Retiring early is a goal many people have. And with enough savings, it may just be possible. There’s a big problem with retiring early, though — health insurance, or a lack thereof.
Many people’s health coverage is tied to a job. If you retire early and don’t have a spouse’s plan to join, you may have to pay for health insurance on your own until you turn 65, at which point you’re generally eligible to sign up for coverage through Medicare.
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But depending on how early you retire, that could translate into multiple years of paying health insurance premiums out of pocket. It could also mean bearing hefty out-of-pocket costs for not having a stellar plan.
That’s why it’s important to consider funding a health savings account, or HSA, if early retirement is on your radar. Having funds in an HSA is a great way to preserve your primary savings if you’re paying for healthcare and don’t want to raid your nest egg extensively.
What’s an HSA?
If you’re not familiar with HSAs, think of them as hybrid savings and investment accounts you can use to cover healthcare expenses — both in the near term and the long term.
It’s easy to confuse HSAs with FSAs, or flexible spending accounts. But a key difference is that HSA funds never expire, which means you can contribute to one of these accounts during your 20s and 30s and then use the money in your 50s and 60s (or later).
In fact, HSAs actually encourage you not to use up your plan balance year after year. That’s because unused money can be invested so it grows into a larger sum.
HSAs are also very useful because they offer three distinct tax breaks:
- Contributions go in on a pre-tax basis.
- Investment gains are tax-free.
- Withdrawals used for qualifying healthcare expenses are tax-free.
However, HSAs aren’t available to everyone. You’ll need to see if your health insurance plan meets the requirements, which change yearly. People who are enrolled in a high-deductible health insurance plan often qualify.
Why an HSA is key when you’re planning to retire early
The cost of having to pay for health insurance may be more than you’ve bargained for. And without an HSA, it may be an impediment to early retirement.
Let’s say you’re aiming to retire at age 59 1/2, which is when you can tap your IRA or 401(k) plan without a penalty. Even if you have a large balance in one of these accounts, you’re a good five and a half years away from being able to get health coverage through Medicare. And you’ll need insurance during that time.
You can’t necessarily use an HSA to pay insurance premiums (though you can use HSA funds for COBRA premiums if you’re looking to retain your employer health coverage for a limited period of time). But you can use an HSA to cover the out-of-pocket costs that may come with one of the less expensive health insurance plans you can buy on your own.
Let’s say you opt for a health insurance plan with lower premiums but significant out-of-pocket costs as a result. Your HSA could come to your rescue by giving you a pool of money to dip into to cover your copays and deductibles.
One of the biggest barriers to early retirement is the need for health insurance. So if that’s something you’re planning for, it pays to see if you qualify for an HSA, and to consider maxing out your contributions.
