Is This the Most Overlooked Tax Break?

Many people look forward to age 65 to be able to start receiving Medicare benefits. Yet eligibility for Medicare doesn’t mean that health care costs simply go away.

According to the Employee Benefit Research Institute, you need to set aside around $140,000 in pre-retirement savings just to handle the eventual costs of prescriptions drugs and various Medicare premiums.

Why not build that $140,000 funding reserve now while shielding that income from taxes? That’s where Health Savings Accounts (HSAs) come in. Not only do contributions to HSAs lower your income for tax purposes during your working years, they also can grow in value on a tax-free basis, and then can be withdrawn tax-free when applied towards medical expenses.

Despite this “no-brainer” tax saver, only 7% of Americans use HSAs, according to a survey completed by United Benefits Advisors. Still, more people are tapping into the benefits of these plans every day. According to HSA advisory firm Devenir, the number of accounts in place grew 6% last year, and thanks to a rising stock market, HSA investment assets surged 52% to an estimated $23.8 billion last year.

Note that HSAs don’t have the “use-it-or-lose-it” feature of flexible spending accounts (FSAs). Unused funds can be rolled over year after year, and you can even invest excess funds in various stock and bond market funds, letting them rise in value at a reasonable pace over time. 

Here’s the catch: you need to be in a high-deductible plan, which many insurers are now focusing upon these days. The minimum deductible for such plans will be $1,400 in 2022 for singles and $2,800 for families and such plans out-of-pocket expenses must be capped at $7,050. (Double those figures for families).  In 2022, the amount you will be able to contribute to an HSA is $3,650 (double that again for families). People age 55 and over can make an extra $1,000 on catch-up contributions. 

Let’s circle back to that $140,000 post-retirement medical expense estimate. If you contribute $3,450 for 20 years, spend $500 per year on HSA-eligible medical expenses in your working years, and the unspent funds grow at 4% per annum, you’ll wind up with $98,000. You’ll also save more than $20,000 in taxes (assuming you are in an average tax bracket). 

To see what expenses are covered with HSA funds, check out this IRS publication.

However, it pays to shop around. A growing number of firms now offer HSA plans, and annual fees and investment choices can vary widely.