Retirement planning overlaps with health-care planning more than you might think. Fortunately, you might be able to prepare for both at the same time.
Sure, retirees will incur many expenses that have nothing to do with health care, such as housing, food, travel and recreation. And many of the health-related expenses retirees face will be covered by Medicare.
But there are still a lot of health costs in retirement that won't be paid by government programs. Fidelity Investments figures two spouses reaching age 65 should plan on budgeting for about $300,000 in combined out-of-pocket health expenses over their remaining lifespans. The Employee Benefit Research Institute estimates the combined costs could be closer to $325,000 on average.
“This is a huge chunk of change” in terms of out-of-pocket health costs that retirees will likely face, said Jake Spiegel, a research associate at EBRI. “Medicare doesn’t cover all expenses.”
So what can you do about meeting such a daunting obligation? Save, invest and make use of the best account choices out there.
Mainstream retirement accounts including 401(k) plans and Roth Individual Retirement Accounts are a big part of the equation. But you also might want to consider Health Savings Accounts, although these tax-favored vehicles aren't right for everyone.
HSAs are flexible investment vehicles and they're portable — meaning an account stays with you even if you switch jobs or leave the workplace. They typically offer a range of investment options and, best yet, they have triple tax advantages.
The accounts are an “absolutely fabulous” way to invest and minimize taxes, said Sharon Carson, an executive director at JP Morgan, while speaking at a recent event hosted by the Employee Benefit Research Institute.
Which tax advantages? First, contributions are deductible. Second, account balances grow tax-sheltered. Third, withdrawals come out tax free if used to meet a range of health-related expenses. Expenses that can qualify for tax-free treatment include surgeries, doctor visits, eye care, Medicare premiums, dental checkups/fillings, nursing-home assistance and prescription drugs.
You could even say HSAs have a fourth tax advantage because there are no required minimum withdrawals. Because of this, and because withdrawals generally are tax-free anyway, you don't need to worry that disbursements might push you into a higher tax bracket or make your Social Security benefits partly taxable. That's not the case with traditional-IRA withdrawals, which can push your Social Security benefits into the taxable category.
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It's hard to find many demerits about Health Savings Accounts based on their tax features. But the plans don't work for everyone, and the tax advantages shouldn't overshadow your medical-insurance needs.
One problem is that not all employers offer Health Savings Accounts as a benefit option. And even where they are available, HSAs are restricted to workers who sign up for high-deductible medical insurance plans. These plans feature lower premiums, which save you money, but the high deductibles might be unaffordable for people living on a tight budget or expecting to face hefty medical costs.
(You also might be able to open an HSA outside of the workplace, but you'd still need to pair it with a high-deductible insurance plan.)
As another demerit, HSA contributions are capped, for 2021, at $3,600 for singles and $7,200 for families, plus an extra $1,000 for people 55 and up. That means you would need years, or possibly decades, to accumulate enough money to make a serious dent in meeting expected health-related costs in retirement.
It's also worth noting that HSA withdrawals not used for qualified health expenses are subject to taxes (plus a 20% penalty if taken before age 65). You can't contribute to a plan once you're enrolled in Medicare, although you can continue to use account proceeds to pay for medical costs. You also can use HSA withdrawals to meet the medical costs of your spouse and dependents.
To accumulate a meaningful sum of money, you'd want to contribute regularly over many years, avoid near-term withdrawals and, if possible, invest your balance in growth assets rather than simply save it. With HSAs, there is no “use it or lose it rule,” Spiegel said, meaning unused account balances carry over to future years. (That's not the case with Flexible Savings Accounts, a separate type of medical-focused vehicle with which HSAs are commonly confused.)
People who get an early start with an HSA could have two, three or four decades with which to work — plenty of time to utilize riskier growth investments such as stock funds.
Yet this isn't how the majority of HSA owners and using the accounts, according to a recent Fidelity study that found people rely mainly on money-market funds or other short-term instruments. Less than 10% of HSA dollars are invested in stock funds and other riskier assets, with the implication that many people are missing a significant opportunity to earn higher returns.
Because HSA dollars can be tapped anytime to pay for medical costs — now, next year or decades later — there’s some uncertainty on when you'll need the money. That explains why many people don’t invest as aggressively as they perhaps should.
One way to deal with this timing uncertainty is to hold a balanced investment mix. Fidelity, for example, offers two funds for use in the HSA programs that it manages. One option, the Fidelity Health Savings Fund, holds about one-third of its assets in stocks and the remaining two-thirds in bonds and cash. The other fund, Fidelity Health Savings Index, holds about 45% in stocks and the rest in fixed income.
If you are a diligent saver, there’s a good chance you are putting away money into various accounts. But are you doing this in an efficient manner based on liquidity, tax savings and other factors? Carson offered some suggestions.
Her first recommendation would be to build an emergency reserve of liquid cash or money market funds that could tide you over for three or six months, if necessary. Once that goal has been met, she suggested turning to HSAs to invest and minimize taxes (assuming you have access to and are comfortable with high-deductible plans).
After that, Carson suggested contributing to 401(k) retirement plans, if available, at least to the extent where you maximize employer matching funds. Fourth, she recommended paying down high-interest debt like credit card balances or student loans.
Assuming you have additional funds to deploy, you could then pay down lower-interest loans, contribute to Roth or traditional IRAs or invest in various taxable accounts, she said. Retirement accounts are important, of course, but "HSAs are more efficient from a tax perspective," she said.
Her recommended saving priorities aren't right for everyone. But for people who can save regularly, pay health costs before retirement with other funds and thereby allow their HSAs balances to grow, it's a strategy that can pay off nicely in retirement.
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