Using a HSA to Pay for Retirement Medical Costs

Heath savings accounts cannot cover all retirement health care costs, study finds.

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Some individuals fund health savings accounts to cover medical expenses later on in retirement. Retirement savers can use these tax-exempt accounts to pay for future out-of-pocket health costs. If distributions are spent on qualified medical expenses no taxes will be due upon withdrawal.

[See 15 Ways to Tell if You Are Ready to Retire.]

Individuals currently enrolled in a high deductible health plan can contribute up to $3,050 to a HSA in 2010 and families can save $6,150. Those age 55 and over can shield an extra $1,000 from taxes. Medicare beneficiaries can’t make new contributions to the account, but retirees can spend the unused funds deposited while working. HSA distributions can be used to pay for Medicare Parts A, B, or D premiums or uncovered expenses, Medicare Advantage plan premiums, and employment-based retiree health benefit premiums tax free.

Employers can also make contributions to HSAs if they stay within the annual limits. While 43 percent of employers are planning to reduce or eliminate their retiree medical plans, according to a recent Towers Watson survey of companies offering retiree medical plans, there’s also increasing interest in diverting some of the funds previously spent on retiree health benefits into HSAs or retirement medical savings accounts.

[See 7 Ways to Protect Your Retirement Savings.]

However, even employees who save consistently using a HSA may not have enough to pay for all of their likely out-of-pocket health care costs in retirement. For example, an investor age 55 in 2009 who contributes $4,000 annually to his HSA and earns 5 percent interest each year with no withdrawals would accumulate $55,100 by age 65, according to Employee Benefit Research Institute calculations. While that will certainly pay for a significant part of likely retirement medical expenses, it probably won’t cover all of them.

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EBRI estimates that a man age 55 in 2009 will need to save between $144,000 and $290,000 by the time he reaches age 65 in 2019 to pay for Medicare premiums and out-of-pocket expenses. So, an individual who saves in a HSA for 10 years is likely to accumulate only enough to cover between 19 and 38 percent of health care costs. Women, who tend to live longer and will need greater savings for retirement health care expenses, face the same contribution limits. “The maximum savings that can be accumulated in a HSA will be far from sufficient to fully cover the savings needed in retirement for insurance premiums and out-of-pocket expenses,” writes Paul Fronstin, a senior research associate for EBRI. Additionally, individuals in high deductable health plans are likely to need to use at least some of their HSA contributions to pay for current health care costs.