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This Could Be a Game-Changer for Retirement Savers

By Matthew Frankel, CFP® - Aug 2, 2018 at 6:08AM

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Legislation that would dramatically increase an important contribution limit just cleared a major hurdle.

The House of Representatives recently passed two pieces of legislation that would make significant changes to health savings accounts (HSAs), including a massive increase in the amount of tax-deferred contributions that could be made to them. These changes could not only allow Americans to get more of a tax deduction for their healthcare expenditures, but they could also help participants build their retirement nest eggs at a faster rate.

Here's a rundown of what the new HSA contribution limit could be, why it matters for retirement savings, and some of the other changes the bills would make.

Pills scattered on top of 100 dollar bills.

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The HSA contribution limit could nearly double

One of the major provisions in the HSA bill known as the Increasing Access to Lower Premium Plans and Expanding Health Savings Accounts Act would dramatically increase the annual contribution limit to these accounts.

For 2018, the maximum HSA contribution is $3,450 for individual health plans or $6,850 for family health coverage. The bill would nearly double these limits, to $6,650 (individual) and $13,300 (family).

The reason for the change? These new limits would be identical to the out-of-pocket maximums that high-deductible health plan participants can be required to pay. The idea is that people will be allowed to contribute enough to their HSAs to cover every possible healthcare expenditure they could face.

Wait -- why does the HSA limit matter for retirement savings?

If you're not too familiar with how HSAs work, you may be wondering why I'm discussing them in the context of retirement savings. However, there's a very good reason.

There are a few excellent features of the HSA that makes this account type an excellent retirement savings vehicle, as well as a great way to help manage healthcare costs. Specifically:

  • HSA contributions are made on a tax-deferred basis, so you get a current-year tax deduction for contributing. Plus, any withdrawals for qualified healthcare expenses are tax-free. An HSA is the only tax-advantaged account that offers this type of double tax benefit.
  • After you contribute, you can invest your HSA funds in a variety of investment options, similar to a 401(k).
  • HSA funds carry over from year to year, so any funds that you don't use to cover healthcare expenses (and the investment returns they generate) can accumulate in the account.
  • Once you turn 65, you can withdraw HSA funds penalty-free for any reason. So you can use them in the same way you'd use any other retirement savings.
  • After 65, withdrawals will be considered taxable income, just as in a traditional IRA or 401(k) -- unless they are used for healthcare costs. The average 65-year-old couple can expect to spend $275,000 on healthcare expenses throughout their retirement, so there should be plenty of opportunities for HSA funds to be used completely tax-free in retirement.

In a nutshell, an HSA has some of the great retirement savings benefits of traditional IRAs or 401(k) accounts, but with the bonus of tax-deductible withdrawals if you need to use your money for medical expenses.

So if participants choose to use their HSA as a retirement savings vehicle, the proposed higher HSA contribution limits could allow them to significantly increase their tax-advantaged retirement savings while maintaining the flexibility to use their money for healthcare expenses if they need it sooner. And after retirement, participants can use HSA funds on a double-tax-advantaged basis to help cover their healthcare cost burden.

To be clear, you need to have a qualifying high-deductible health plan to be eligible to use an HSA to save. Specifically, you need to have a healthcare policy with a deductible of at least $1,350 for an individual or $2,700 for a family.

Other HSA changes contained in the bills

It's also important to mention that the HSA bills that passed the House would do a whole lot more than raising the HSA contribution limits. Here's a rundown of some of the most significant changes they would make in their current form:

  • HSA funds could be used to purchase over-the-counter (OTC) medications and health products. Currently, this is not an option, and allowing HSA funds to be used for OTC products could help people save money.
  • Individuals whose spouses are enrolled in a flexible spending account, but who otherwise qualify for an HSA, would be allowed to contribute to an account. Currently, doing so is prohibited.
  • High-deductible health plans would be allowed to cover as much as $250 annually for an individual, or $500 for a family, for certain services on a pre-deductible basis.

What's next for the HSA bills?

These bills have only passed the House. They still need to clear the Senate before they can become law, and they're likely to face some significant resistance there. Many Senate Democrats aren't fans of the high-deductible health plans that HSAs are designed to complement, and the bills will need some degree of bipartisan support to pass.

Having said that, there is a lot in these bills that should make both sides of the political spectrum happy, so there's a realistic chance that they could make it through the Senate in the not too distant future and become law.

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