Paying for Medical Expenses in Retirement
Failing to plan for future medical expenses can derail your early retirement dreams. Consider these two options to help save for future medical needs while also lowering your taxes and expenses.
Flexible Savings Account
A great way to cut your health-related expenses is to set up an account that contributes pre-tax dollars to be used for health-related expenses. The first type of account is a Flexible Spending Account (FSA). The FSA is available to people who have health insurance, but their plan has a low deductible. The deductible is the part of the bill that the insured person must pay out of pocket for any health care services they receive. The differences between low and high deductible are explained below.
The maximum contribution for an FSA for for 2020 is $2,750. An FSA has one major drawback, if you do not spend the money contributed during the year, you will forfeit the money back to your employer. Fortunately for all of us, there are two exceptions to the forfeit rule. The first allows the account owner to roll $500 of their balance into the plan for next year. The second allows the account holder an additional 2½ months beyond the end of the year to use the money for health-related expenses. Your FSA plan will have one option or the other but not both. The IRS rules don't currently allow FSA plans to have both options. So, if you sign up for an FSA make sure you can spend the account balance. Your payroll or human resources office can help you set up an FSA and explain the benefits.
Health Savings Account
The second type of account is a Health Savings Account (HSA) which is for people who have a high deductible health insurance plan. Employers are increasingly switching to high deductible plans because they are less expensive to offer. This is an example of employers shifting the cost of employment benefits to their employees. If you don't have a high deductible health insurance plan, consider using the FSA described above. If your employer offers an HSA you sign up for their program, the automatic contributions from your payroll will save you 7.65% in FICA tax for Social Security and Medicare. This is a savings over applying for an HSA with a financial institution,
The U.S. Internal Revenue Service determines the threshold for what constitutes a high deductible health insurance plan which is found in IRS Publication 969. For 2020, a high deductible health insurance plan has an out-of-pocket maximum of $6,900 and a minimum deductible of $1,400 for an individual. For a family plan, the out-of-pocket maximum is $13,800 and the minimum deductible is $2,800. You can review your health insurance plan to confirm your deductible and out-of-pocket expenses.
The benefit of a HSA, unlike an FSA, is that the money in the account will carry over year to year and can be used for future medical expenses. For 2020 an individual can contribute $3,550 per year and a family can contribute $7,100 per year to an HSA. The HSA funds can then be invested in various assets such as stocks and bonds. Like other tax deferred accounts there is a “catch up” provision that allows individuals age 55 and older to contribute $1,000 more to their HSA either as an individual or a family. Once you are age 65 and enroll in Medicare, you can no longer contribute to an HSA, but the money in your HSA may be withdrawn for any reason (not just medical expenses), but the proceeds will be subject to income tax. If you are eligible for an HSA, it can be a fantastic way to build in some additional savings for future health related expenses.