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Make Your Health Savings Account Work For You In Retirement

By Sarah Rubenstein, The Wall Street Journal

Health savings accounts are looking more attractive; but they still may not be powerful enough to cover all of your health-care costs in retirement.

The accounts, which were created in 2003, are getting a lot of attention these days, even though they're still used by relatively few people. Some employers see them as a way to save on health-care costs. More banks are offering them, and today, President Bush is expected to sign into law a bill that sweetens their potential as savings vehicles.

The accounts allow consumers with high-deductible insurance plans, either from an employer or purchased on their own, to avoid taxes on contributions, investment growth and withdrawals as long as the money is used for qualified medical expenses. Still, crunching the numbers shows that it would be quite difficult to use an HSA to foot your entire health-care bill in retirement. But with enough planning, you could use it to pay for a significant chunk of the tab.

Most people don't realize how much money they could need to fund their retirement health-care costs. Despite the fact that Medicare pays for many health costs for seniors, someone who retires today at 65 and lives 20 more years could need $84,000 to $164,000 to pay for uncovered medical expenses, according to a report by the nonprofit Employee Benefit Research Institute released earlier this year. And that's not counting long-term care costs.

How much you'll need depends heavily on how high your out-of-pocket drug costs will be. (That $164,000 figure assumes high drug costs.) The money will go toward paying premiums for Medicare Part B, which covers physician and outpatient care, premiums for a standard Medicare prescription-drug plan, out-of-pocket prescription-drug costs not covered by that plan and a supplemental insurance plan for other uncovered expenses. Bear in mind that today's $164,000 estimated costs will likely rise substantially for future retirees, according to the EBRI.

Beginning next year, you must have a qualified health-insurance plan with a deductible of at least $1,100 for an individual, or $2,200 for families to open an HSA. An individual will be allowed to contribute up to $2,850 a year to the account; for families, the limit is $5,650. Before Congress passed its changes this month, your contributions couldn't exceed the amount of your deductible.

Even with that adjustment, the contribution limits can be a snag. Here's why: Suppose the government increases the $2,850 limit by 2.5 percent annually, and the money in your HSA realizes a 5 percent return each year. To amass around $164,000 before you turn 65, you couldn't be older than 41 or 42 this year, based on an analysis using EBRI formulas, and even then that amount might not be enough because health-care inflation could well drive the goal figure much higher.

This analysis assumes the HSA holder has a qualified insurance plan every year and contributes the maximum amount annually. This person also doesn't spend any of the money before age 65. The EBRI says today's 55-year-olds who retire 10 years from now and have high drug costs could actually need about $298,000 from age 65 on, factoring in health-care inflation.

Yet an HSA, when used properly, has a big advantage over a 401(k), in which funds are taxed when they're withdrawn. Depending on your tax bracket, you could have to accumulate some $252,000 in a 401(k) for those funds to be equivalent to $164,000 in non-taxable funds for health costs in an HSA.

Once you're 65, you can also use HSA savings for non-health expenses without penalty. Those withdrawals are simply taxed as income, much like a 401(k).

To maximize your HSA, start young. Contributing regularly will get you a lot further if there are decades to do it. And, even though you're allowed to spend your HSA on health expenses before retirement, try to cover those costs with other funds.

By leaving the money in your HSA, you can accumulate interest and investment returns that will not be taxed later, assuming you ultimately spend the money on health expenses. If, instead, you spent your HSA money on present-day health expenses and saved after-tax dollars, the growth of those savings would in many cases be taxed, reducing their overall value.

The temptation to spend the money now, though, can be tough to resist. The high-deductible insurance plans that are paired with HSAs can expose consumers to significant costs before coverage kicks in. It probably doesn't make sense to go into credit-card debt, for instance, for the sake of leaving money in your HSA.

But consider a 41-year-old who could build up that $164,000 by saving the maximum amount each year. If that same person took $1,000 a year out of her HSA, she would wind up with only about $125,000, according to an analysis using EBRI formulas.

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