Ten Steps to Reforming Baby Boomer Retirement

Policy Reports | Retirement

No. 283
Thursday, March 23, 2006
by John C. Goodman, Devon Herrick, Matt Moore

Step 9. Creating Health Savings Accounts for Seniors

Figure VIII - Annual Medical Expenditures by Age

Currently, the elderly pay half their health care costs out of pocket. These expenditures often come from wages and other taxable income. Even with the new Medicare prescription drug benefit, seniors' health care costs will continue to climb. [See Figure VIII.]

HSAs could provide seniors a way to save pretax dollars to pay their health expenses. Unfortunately, seniors eligible for Medicare are not allowed to establish new HSAs or make additional deposits to existing accounts.48 And there are other restrictions on HSAs that make it difficult for younger people to accumulate funds that could help meet their needs after retirement.

Flexible HSAs Prior to Retirement. Health Savings Accounts are needlessly restricted. Under current law, the annual HSA contribution is limited to the health plan deductible, up to a maximum of $2,700 per individual and $5,450 per family. But this may not be enough to accumulate funds sufficient to meet many people's health needs after retirement.

Ideally, reforms would allow unlimited contributions to HSAs and permit the accounts to wrap around third-party insurance - paying for any expense the insurance plan does not pay. Allowing nonseniors to deposit more funds into an HSA earlier in life would help build up balances for retirement, when health needs are greater. At the very least, people (and their employers) should be able to make an HSA deposit each year equal to their total out-of-pocket exposure, as President Bush has recently proposed.49

"Seniors should be able to contribute to Health Savings Accounts."

HSAs for Seniors. Allowing Medicare-eligible seniors to make HSA deposits would help them build balances for when the need arises. Individuals aged 65 to 74 years spent about $9,094 per year on health care in 2000. However, individuals aged 75 years and above spent nearly three-fourths more (about $15,756).50 Thus, during later retirement most seniors will have higher medical bills than at any other time in their lives. If younger seniors were allowed to continue depositing funds - and accumulating interest - they could better afford the out-of-pocket portion of future medical bills.

Roth HSAs for Seniors. Another way to provide relief to the age-65-plus population is to let seniors turn their Roth IRAs into Roth HSAs. Today, funds in Roth IRAs may be withdrawn at any time without penalty for health care. Once a person turns 59½, any remaining funds not spent on health care can be withdrawn without penalty and spent on other goods and services or left to grow with interest. This levels the playing field between current and future spending, and between health care and other spending. However, while Roth IRAs represent an attractive way for seniors to build up savings for medical contingencies, they still have rules and restrictions that make them less flexible than they could be.

Allowing conversion of Roth IRAs into Roth HSAs could be accomplished by making three changes: 1) Lift the five-year waiting period before withdrawals for health expenses, 2) allow deposits even in the absence of wage income, and 3) remove income limits on participation.

Needed Change: Lift the Five-Year Moratorium on Withdrawals. Current law imposes a five-year moratorium on Roth IRA withdrawals. While that restriction may make sense if the goal is to encourage retirement savings, it interferes with planning for health expenses, where decisions ordinarily are made each year. If the moratorium were lifted specifically for health care purchases, senior citizens would be able to integrate their Roth IRA with Medicare and Medigap coverage.

Needed Change: Allow Roth HSA Contributions Irrespective of Wage Income. Under current law, deposits to a Roth IRA cannot exceed wage income in any given year. Yet the need for savings for health expenses is not limited to those who remain in the labor market. After all, most seniors are retired.

"Seniors should be able to convert their Roth IRAs into Roth Health Savings Accounts."

Needed Change: Allow Roth HSA Contributions without Income Limits. Under current law, taxpayers who file as a single with an adjusted gross income more than $110,000 cannot contribute to a Roth IRA, and cannot make the full contribution if their adjusted gross income is between $95,000 and $110,000. Taxpayers who are married filing jointly cannot contribute to a Roth IRA if their adjusted gross income is greater than $160,000, and can only make a partial contribution if their income is between $150,000 and $160,000. Yet the burdens of health care expenses do not end when income exceeds these limits. Accordingly, an expanded Roth IRA for health care should be available to all seniors regardless of income. Even if the annual contribution limits for Roth IRAs are maintained under current law, deposits to Roth HSAs should be available to all.

A Roth HSA would be designed as a wraparound account. It would provide funds with which to pay medical bills not paid by third-party insurance. For seniors who have only Medicare coverage, the Roth HSA could be used to pay expenses not paid by Medicare. For those who have both Medicare and Medigap insurance, the Roth HSA could be used to pay expenses not paid by either.

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