If you don’t anticipate rising medical costs during your retirement, you may have a rude awakening. According to a study conducted by Boston College’s Center for Retirement Research, the average 65-year-old household will pay $67,260 in medical bills for the rest of their lives.
This is what you will have to pay even after paying your health insurance and any supplementary health insurance premiums. And if you are unlucky enough to be among the top 10% spenders on medical care, you will need to find around $138,000 to cover your medical expenses.
If you plan for it, though, there can be a great way to cover those medical expenses in retirement.
This savings superpower in an HSA
An HSA, or Health Savings Account, is a special account available to people enrolled in certain high-deductible health insurance plans. The idea is that people on these plans should save for infrequent medical expenses, which can be significant because they have very high deductibles. The government offers them a tax incentive to save with the HSA.
All contributions to an HSA are tax deductible in the year they are made. Plus, if you withdraw funds for eligible medical expenses, you won’t pay taxes on those expenses either. And any interest or account growth is also not taxed. As an added bonus, if you are able to contribute to your HSA through payroll deductions at work, you can also save on FICA tax.
HSAs are commonly used to pay for large medical expenses as they are incurred. But that doesn’t have to be the case. If you can afford to pay for medical expenses with funds outside of your HSA, you can leave the money there and withdraw it for that expense, without tax or penalty, at any time in the future.
You can invest the money in an HSA. If your current HSA provider doesn’t have a brokerage option, you can move it to one that does. The longer you leave money in your HSA, the more time it has to grow tax-free. This is the superpower of using an HSA.
Planning for medical expenses in retirement
HSA-eligible plans aren’t for everyone. First, you must be able to afford the high deductible. If you cannot afford to cover the deductible in the event of a medical emergency, you will need another insurance plan.
Second, the HSA-eligible plan must be worth it to you. If you have regular medical expenses covered by another insurance plan, you may want to use that plan instead of a high-deductible plan.
But many people are healthy and don’t have big medical expenses in their 20s and early 30s. That makes those years the perfect time to build a big HSA nest egg.
Someone who maxes out their HSA from age 26 (when pushed back from their parents’ insurance plan) to age 35 will be in a great position to cover their medical expenses in retirement.
The contribution limit for an HSA in 2022 is $3,650. If a person diligently puts that money into an HSA at the beginning of each year from age 26 for the next 10 years, they will have contributed $36,500 in total. (The IRS adjusts the contribution limit annually to reflect inflation, but we’ll ignore that.)
If that person earns an average of 5% on their contributions, they will have about $46,000 by the time they turn 36. And if she continues to earn 5% on this account, she will reach age 65 with nearly $200,000 in an HSA. .
This should be enough to cover the vast majority of medical expenses for retirees. And if you kept your receipts for all the medical expenses you incurred along the way, you can withdraw funds completely tax-free based on those past expenses and use them for other living expenses.
Of course, if you’re already over 35, that doesn’t mean you can’t get the most out of an HSA if you still have access to one. You will still be able to take advantage of the tax benefits offered by the account, even if you don’t have enough to cover all of your medical expenses in retirement. Just be sure to save enough outside of your HSA to cover the increased medical costs you may expect in retirement.