The IRS Retirement Loophole
How are you going to survive financially in retirement?
By one estimate, a 65-year-old U.S. couple retiring in 2017 will need a minimum of $13,000 per year for 20 years – $260,000 before inflation.
I don’t have to tell you what it would be like to live on $13,000 a year, or $1,083 a month. I’m sure you can imagine it perfectly well. Just start subtracting optional items and paring back essentials until you get to that figure.
Not a pretty picture, is it? Now add in health care expenses.
Thirteen grand a year isn’t going to cover much, if anything… especially if Republicans in Congress succeed in their long-standing goals of transforming Medicare into insurance vouchers and reducing Social Security benefits.
How about saving more for retirement? I hate it when so-called “financial advice” columns tell me to do that. It’s like telling a starving person to eat more. They would if they could.
Fortunately, there’s a “hack” you can apply to existing tax and insurance regulations that might allow you to do an end run around the threat of a poverty-stricken retirement…
If you don’t know what a health savings account (HSA) is, it’s time to find out.
If you have good health, good luck and the financial wherewithal to pay most of your health costs out of pocket before you retire, an HSA could be a great way to save for the health care bills you’re going to face in retirement… and therefore make your overall retirement kitty stretch further.
An HSA is a tax-advantaged savings account into which you contribute pretax money, like a 401(k) or IRA. It lowers your current tax bill, and when your HSA administrator invests the money, it grows tax-free just like in any retirement account.
If you use the HSA money for qualified medical expenses, you don’t owe any tax on that money at all. Ever. That makes an HSA even more advantageous than a 401(k) or IRA, where your post-retirement withdrawals are taxed as ordinary income.
And unlike those retirement plans, there are no required minimum distributions for HSAs. If HSAs become heritable, as the Trump administration seeks, any balance could be passed on to your surviving spouse and/or heirs.
Pay and Save Now, Retire Later
There’s one catch, though.
HSAs are only available to people with a high-deductible health insurance plan. Under IRS rules for 2017, that means plans with a deductible of at least $1,300 for single people, or at least $2,600 for family coverage. That’s how much you must fork out annually before insurance kicks in.
In the real world, the average deductible for people with a high-deductible plan combined with an HSA is about $2,295 for single workers and $4,364 for family coverage. You need to be able to spend at least that much on your own health care now to take advantage of an HSA. (The maximum out-of-pocket expense for deductibles and copays for people with high-deductible plans is $6,550 for individuals and $13,100 for family coverage in 2017.)
Of course, high-deductible plans have lower premiums than traditional plans, which is a bonus. But to make an HSA work for retirement, you need to take the money you save on lower premiums and put it into the HSA now.
That seems to be precisely how people are using HSAs. A Congressional Budget Office study found that the majority of people with HSAs were paying for current medical costs, including surgery and other large expenses, out of current income so they could maximize their contributions to their HSA.
If you are disciplined about saving and have enough monthly cash flow to cover your current health costs, letting tax-free HSA money grow tax-free will provide another stream of income when you retire… one that will make it unnecessary to use your other retirement income for health care costs.
Be Ahead of the Curve
With all those benefits, HSAs are a great hidden benefit of the current U.S. tax code. The only downside is the need to go the high-deductible route with current medical insurance.
But we may not have much of a choice about that anyway. Republicans have been pushing for more high-deductible plans for years, and Trump says he wants to encourage them too.
On top of that, Obamacare’s so-called “Cadillac tax,” which taxes the value of the most generous employer health plans, is slated to go into effect in 2020. That threat is already pushing employers toward high-deductible plans.
Of course, most companies, in general, want to lower their health costs regardless of Obamacare or any other legislation. That’s why a growing number of U.S. employees are covered by a high-deductible health plan paired with an HSA: a 25% increase from 2015 to 2016 alone.
But Wait… There’s More
Generally, qualified expenses for HSAs are the same as those for claiming the medical expense deduction on your 1040 tax return. But there’s one allowable deduction that’s a real winner for many of us… subject to a certain maximum, premiums you pay for long-term care insurance can come out of your HSA, tax-free.
That means you can increase your tax-free savings for retirement medical costs and reduce those costs through insurance that covers the most expensive parts of it.