Managing Your Health Savings Account into Retirement

A Health Savings Account is a powerful ally during retirement. Learn what you need to do when you retire - and afterwards - to unlock these powers.

Last week, we focused on how to manage your Health Savings Account during pre-retirement transitions, including job loss and an expanding family. This week, we look at managing your account during retirement and the end of your life.

Your Health Savings Account in Retirement

A handful of organizations calculate how much the average retiree spends on medical and other health-related care in retirement. They use different approaches, but most cluster around the $315,000 figure that Fidelity estimates a couple retiring at age 65 this year will need during their remaining lifetime (about 18 years for men and 20 for women on average).

That figure is deceptive, as it doesn't include the effect of taxes when you withdraw funds from a tax-deferred retirement account. You'll need to distribute between $358,000 (12% federal income tax rate and no state taxes) to $384,000 (12% federal income and 6% state income tax rates) to spend $315,000. When you've funded a Health Savings Account, you can make tax-free withdrawals to reimburse those same expenses.

What do these expenses include?

• Medicare cost-sharing (deductibles, coinsurance, copays). Qualified for tax-free withdrawals from a Health Savings Account.
• Services above Medicare limits (extra hospital and skilled-nursing days). Qualified for tax-free withdrawals from a Health Savings Account.
• Services that Medicare doesn't cover (acupuncture, hearing aids, orthotics, most dental and vision services). Qualified for tax-free withdrawals from a Health Savings Account.
• Medicare cost-sharing (deductibles, coinsurance, copays. Qualified for tax-free withdrawals from a Health Savings Account.
• Medicare Part B (outpatient care) and Part D (prescription-drug coverage) monthly premiums. Qualified for tax-free withdrawals from a Health Savings Account.
• Medicare Part C (a private alternative to Medicare) premiums, if applicable. Qualified for tax-free withdrawals from a Health Savings Account.
• Medicare Supplement plan premiums to reimburse some of Medicare's out-of-pocket costs. Not qualified for tax-free withdrawals from a Health Savings Account.

In addition, seniors who continue to pay premiums for long-term care (nursing homes and in-home alternatives, which aren't covered by Medicare) can pay their premiums (up to limits set annually) with tax-free distributions from their Health Savings Account.

Distinct Advantages of a Health Savings Account in Retirement

The bulk of Americans' retirement savings are in tax-deferred accounts. These vehicles allow workers to deduct from taxable income (at both the federal and state levels) the contributions that they make to these accounts (subject to annual limits). In exchange, they must pay taxes on all withdrawals. In effect, savers reduce their tax burden, thus allowing them to contribute more to their retirement, at the expense of paying taxes (perhaps at a lower rate, since retirees' incomes are generally lower than during their working years) on withdrawals in retirement.

Health Savings Accounts offer three distinct advantages over these tax-deferred 401(k) plans, 403(b) plans, Individual Retirement Arrangements, and other vehicles:

Required Minimum Distributions. The federal government doesn't allow retirement funds to grow tax-free forever. Beginning in the year that they turn age 73, tax-deferred retirement-account owners must begin to make distributions, the amount of which are based on their total balances in all tax-deferred accounts and their projected remaining lifetime from actuarial tables. They must withdraw the RMD amount whether or not they need the money, whether or not they want to retain the funds to grow after a down year in the market, whether or not the distribution will affect their tax situation negatively.

In contrast, Health Savings Accounts have no RMD requirements. Owners alone determine when and how much they withdraw from their accounts.

Income-Related Monthly Adjustment Amount (IRMAA). The federal treasury subsidizes Part B premiums, leaving the average enrollee paying only about a quarter ($164.90 is the base premium in 2023). It also subsidizes a similar percentage of Part D premiums, which vary by plan and insurer (these prescription-drug plans are offered by private companies regulated by Medicare.) With higher income, the subsidies are reduced, leaving enrollees to pay a higher monthly premium.

All withdrawals from a tax-deferred account are included in the IRMAA calculation, so higher distributions - even for qualified medical expenses - can result in higher Medicare premiums.

In contrast, Health Savings Account withdrawals for qualified expenses are reimbursements, not income, and thus don't affect the IRMAA calculation. For a senior whose income is on the cusp of the next higher Part B premium and Part D premium surcharge, withdrawing funds from a Health Savings Account rather than a tax-deferred retirement account can save $900 or more that year in higher Medicare premiums.

Provisional Income. Depending on your income, either 0%, 50%, or 85% of your Social Security check will be included in your taxable income. The percentage is based on your provisional income, which includes half your annual Social Security benefit, all pension payouts, all distributions from a tax-deferred retirement account, all rents, and most interest (including on tax-free municipal bonds). If that figure exceeds the thresholds ($34,000 for single filers and $44,000 for joint filers - figures that are not indexed for inflation), the percentage of your Social Security benefit that's taxed increases from 50% to 85%.

The average Social Security benefit in 2023 is just under $22,000. The difference between 50% ($11,000 taxed) and 85% ($18,700 taxed) is an increase in taxable income of $7,700, resulting in additional income taxes of between $924 (12% federal rate) and $1,540 (20% combined federal and state rate).

As noted, all distributions from a tax-deferred retirement account are included in the provisional-income calculation. In contrast, Health Savings Account withdrawals for qualified expenses are reimbursements, not income, and therefore aren't included in the formula.

Know When to Stop Contributing

If you don't enroll in Medicare when you're first eligible around your 65th birthday, your Part A coverage will apply retroactively when you do enroll. Part A enrollment is backdated up to six months, but in no case does it extend prior to your 65th birthday. Thus, if you enroll

• effective the month of your 65th birthday, you have no retroactive coverage.
• effective between the month of your 65th birthday and the fifth month after that month, your coverage is retroactive to the month of your 65th birthday.
• effective the month that you turn age 65 1/2 or older, your coverage is retroactive six months.

Knowing when your retroactive coverage begins is important for your Health Savings Account contributions. You can't contribute for any month that you're enrolled in Medicare. Thus, if you enroll in Medicare effective the month of your 67th birthday, your Part A coverage is retroactive six months. You can't fund your Health Savings Account for those six months.

Choosing Your Administrator

During your working years, your company probably aligned with a single administrator to simplify its moving money - the company's contributions to your account and your pre-tax payroll deductions - from the company payroll system to employees' Health Savings Accounts. In retirement, that administrator may or may not be appropriate.

Here are some considerations:

• Does the administrator charge a monthly fee to maintain the account? Employers often pay this fee for active employees. But you will assume this responsibility if the administrator charges a fee.
• Do you have easy access to your balances? In retirement, you won't be contributing additional funds, so your focus shifts to distributions. Does the account offer a debit card (almost all do)? Can you link your personal account easily to your Health Savings Account to expedite electronic reimbursement (including repaying you for your Medicare Part B premium, which is deducted from your Social Security check).
• Is the investment platform appropriate? Your focus may shift from maximizing your returns to preserving your balance with some growth for expenses that you may incur later in retirement. Does your administrator offer an appropriate mix of investment options to accommodate this shift in your strategy?

Final Disposition of Your Balance

Retirement isn't the end of the story. Your retirement ends with your death. You don't manage your Health Savings Account after your death, but you have an important decision to make when you're alive: Who will inherit your unused balances?

You name a beneficiary (or beneficiaries) when you open the account, and you can change your designation at any time. You can name anyone as beneficiary, but the tax benefits are extended only if you name your spouse. We explored this topic in depth in an HSA Wednesday Wisdom column earlier this month.

Your estate representative can withdraw funds tax-free up to one year after your death to pay qualified expenses that you incurred prior to your passing. Those tax-free reimbursements can be applied to any expenses that you incurred after you established your initial Health Savings Account. This approach is optional. It may make sense to maximize the tax benefit of an account whose beneficiary is a person or entity other than a spouse.

The Bottom Line

Your Health Savings Account offers so many benefits in retirement. It's important to understand these benefits decades before retirement so that you can adjust your savings (amounts and accounts) to maximize your spending power in retirement. But even if you don't you must reassess your account features as you transition into retirement to determine whether your current administrator offers you the optimal account for this phase of your financial life.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.