Tax-free health savings accounts would have a bigger role for Americans under the ill-fated Senate Republican proposal to repeal and replace Obamacare. But many people have them already, or are thinking of starting up, raising tricky questions about what to do once they’re also eligible for Medicare.
Health savings accounts have a dual life, serving as investments as well as paying for health care. Holdings can go into mutual funds, for example, and grow tax-deferred like in an individual retirement account or 401(k), and can be used for any purpose in retirement if not spent on health care.
What should you do with funds in an HSA once you turn 65 and start receiving Medicare benefits? Is having both like wearing a belt with suspenders?
Not necessarily, as an HSA can be used for medical expenses not covered by Medicare, such as premiums for supplementary Medicare insurance, says Ryan McCostlin, an HSA expert at Bernard Health advisors based in Nashville, Tennessee. Other eligible expenses not covered by Medicare include in-home and nursing home care, dental care, eye exams, hospital expenses and prescriptions.
“Most people should keep their HSA after they enroll in Medicare, and that’s because an HSA allows you to spend pre-tax dollars on health care at a time when you’re likely to need it most,” McCostlin says. “You can even use HSA money to pay for Medicare-related insurance premiums with pre-tax dollars.”
[See: 9 Ways to Avoid 401(k) Fees and Penalties.]
Michelle Herd, a financial planner at TFC Financial Management in Boston, advises keeping an HSA after enrolling in Medicare, even though new contributions are not allowed.
“If you have an HSA account, you should continue to keep the account open and use the funds for qualified medical expenses as needed before and during the time you’re enrolled in Medicare,” she says.
HSAs are typically offered by employers, though it’s also possible to set one up on your own. Like a 401(k) or tax-deductible IRA, the HSA allows the participant a tax deduction on contributions. Contributions and withdrawals are tax-free if used for approved medical expenses.
The maximum annual contribution for 2017 is $3,400 for an individual, $6,750 for a family, though policyholders 55 and older can put in $1,000 more. The account must be coupled with a high-deductible insurance plan — one with maximum out-of-pocket expenses of at least $6,550 for an individual and $13,100 for a family. Medicare does not qualify because it is not a high-deductible plan.
Money not spent in a given year can be rolled over, or used in the future. And HSA withdrawals for non-qualified expenses are taxed as income and charged a 20 percent penalty if the policyholder is not 65 or older.
After 65, the policyholder can withdraw for any purpose and pay tax but no penalty, making the HSA like a traditional 401(k), though withdrawals for medical expenses continue to be tax free.
Experts say people eligible for Medicare should keep several things in mind:
Don’t delay. Once you are eligible for Medicare you cannot open a new HSA, or make fresh contributions to an existing one. “It is important to note that an HSA cannot be opened after enrolling in Medicare because in order to be eligible for an HSA the individual must be enrolled in a high deductible health plan,” says Chad Wilkins, executive vice president of Webster Bank and head of HSA Bank, based in Wisconsin.
Keep an existing HSA. Although you may be tempted to cash out, it may be best to keep the account to pay out-of-pocket medical expenses not covered by Medicare. “After age 65, approximately 25 percent of medical expenses will be on out-of-pocket costs such as hospitals, doctors and tests, and prescription drugs, while 75 percent of costs will be on medical premiums,” Wilkins says.
[See: 10 Tips to Boost Your IRA Balance.]
That typically means premiums for Medicare B and D policies. Many Medicare enrollees use HSAs to pay premiums on long-term care insurance, he says.
HSA funds can also be used for dental and eye care, which are not covered by Medicare, says Leigh Bennett, a Dallas-based certified Medicare specialist for IMA, a national insurance broker.
Shop around. “Although you cannot open an HSA while on Medicare, you can continue to hold and manage an account you set up and funded before you enrolled in Medicare,” Herd says. “You are allowed to move an account between HSA providers without a penalty or tax consequences if you do so directly” and don’t have the money sent to you.
She recommends shopping for the plan best suited to your post-65 needs.
“A few items to consider are the costs for maintaining the account and the investment options and fees that are available to you through different providers,” she says. “It’s also important to consider how easy it is to access the account — many offer debit cards — and how reliable the record keeping is for tax purposes.”
McCostlin says anyone shopping for an account to be kept past 65 should look for one that offers investment in stocks or stock funds rather than just bank savings, to benefit from tax-free growth.
Name a beneficiary. Herd says an HSA left to a spouse continues to enjoy favorable tax treatment, as if it had been the spouse’s all along, so long as proceeds are used for qualified medical expenses.
[See: 8 Things That Matter More Than Money for a Happy Retirement.]
“If the beneficiary is anyone other than your spouse, the account will no longer retain the tax-favored status but will be paid to the beneficiary as part of your estate and will be subject to the applicable taxes,” she says.
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HSAs Offer Benefits for Older Investors originally appeared on usnews.com
