NCPA - National Center for Policy Analysis


November 11, 2008

Health savings accounts (HSAs) were introduced in 2004 and allow individuals to pay for medical services upfront through funds they deposit tax-free into a personal account.  A required insurance policy then kicks in for catastrophic expenses.  Any unused funds build up from year-to-year and collect interest in the process.

But do health savings accounts make financial sense?  Recent guidelines issued by the Internal Revenue Service put HSAs on equal footing with Individual Retirement Accounts from a tax perspective.  But HSAs offer benefits IRAs simply cannot, say researchers. 

"Put simply, no other account has the tax advantages that HSAs do," says Roy Ramthun, co-author of a new report from the Flint Hills Center for Public Policy and a Visiting Fellow at the Council for Affordable Health Insurance.  "Throughout the life of an HSA its owners can withdraw funds for medical care tax-free.  Because of this, taxpayers should consider fully funding their HSAs first, before other types of retirement accounts."

For example:

  • Medical care in retirement can be extremely expensive and demands adequate planning and saving; Fidelity Investments, for example, estimates that "an average 65-year-old should plan for at least $551 monthly or $6,631 annually in healthcare expenses."
  • For a couple retiring in 2008, that can add up to $225,000 over the rest of their lifetimes after taking into account all the expenses Medicare covers; even worse, that figure does not include long-term care expenses.
  • The number is not likely to drop any time soon, either; in fact, over the past several years the average annual increase has held steady at roughly six percent.

"With health care costs continuing to outpace wage increases and companies trimming retiree health benefits," said Fidelity Executive Vice President Brad Kimler in a recent release, "financing health care has to be central to retirement planning."

The beauty of HSAs is that they can be used to pay Medicare premiums, out-of-pocket expenses, long-term care insurance premiums, and many long-term care expenses, say researchers.  Even better, HSAs can do all of this tax-free.  However, if you don't end up incurring these types of expenses, you can still use your HSA funds for other purposes and pay only regular income tax on your withdrawals after age 65.

Source: Roy Ramthun and Matthew Hisrich, "What can a health savings account do for you?: The tax, savings, and health spending advantages of HSAs," Flint Hills Center for Public Policy, October 28, 2008.


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