Retirement Income

How To Use Your Health Savings Account (HSA) For Retirement Once you turn 65, you can use them for anything you want—without incurring penalties. Health Savings Accounts (HSAs) are designed to cover future medical expenses. But that’s not the only way to use them. Thanks to their tax benefits and withdrawal rules, HSAs can make a valuable addition to your retirement plan. In this guide, we’ll cover: HSA eligibility The benefits of HSAs HSA contribution limits HSA withdrawal rules Using an HSA for retirement Am I eligible for an HSA? To be eligible for an HSA, you have to: Be covered under a high deductible health plan (HDHP). Not be enrolled in Medicare. Not be claimed as a dependent on someone else’s tax return. Have no other health coverage except what the IRS covers under “Other Employee Health Plans.” Your employer may have information on HSA providers available to you. The expanded IRS rules can provide more detailed eligibility information. What are the benefits of an HSA? Health Savings Accounts have a couple tax benefits that help you make the most of your assets. Your contributions are pre-tax, meaning you can deduct them from your income taxes. You can use these funds at any time to pay for qualified medical expenses without paying taxes or penalties. And when you turn 65, you can use your HSA for anything without incurring a penalty. While you must have a high deductible health plan in order to contribute to your HSA, your HSA isn’t tied to a specific employer. It stays with you when you change jobs or retire. The money doesn’t leave the account until you use it. Also, your employer may contribute to your HSA—and since the contribution is pre-tax, it doesn’t count toward your gross income. Some HSAs are specialized savings accounts. But some are actually investment accounts. Any interest and earnings that come from these HSAs are tax-free provided you don’t use them on unqualified expenses before you turn 65. So HSAs can rank amongst the best ways to save for retirement, on par with some 401(k)s and IRAs depending on factors such as an employer match, fees, and/or investment choices. HSA contribution limits In 2024, the HSA contribution limit for self-only HDHP coverage is $4,150, while the limit for family HDHP coverage is $8,300. HSA withdrawal rules Need some money to cover unexpected medical costs? Make a tax-free withdrawal. Don’t need it? Save it for your retirement. Withdrawing from an HSA for non-medical expenses comes with a 20% penalty . . . unless you’re over 65. Once you turn 65, withdrawals from an HSA work a lot like withdrawals from a traditional IRA or 401(k). Your withdrawals count toward your annual income, so you’ll pay income taxes based on your tax bracket. However, if you use your withdrawal to pay for medical expenses, it’s still tax-free. Basically, there are three possible outcomes when you withdraw from an HSA—and it all comes down to your age and what you use the money for. Your age Qualified Medical Expenses Other Expenses Less than 65 years old No taxes, no penalty Taxes are applicable, 20% penalty 65 years old or older Taxes are applicable, no penalty How to use your Health Savings Account for retirement When you reach retirement age, medical bills can start to add up quickly. Use your HSA to cover these expenses, and you’re triple-dipping on the tax benefits! Your contributions are tax free, your interest and earnings are tax free, and so are your withdrawals. From a financial planning perspective, that’s hard to beat. And it can make expenses like long-term care a lot less frightening. But an HSA is also a great supplement to your IRA or 401(k). Since the 20% penalty disappears when you turn 65, you won’t have to worry about whether an expense is qualified—just use your money as you see fit. Considerations before you choose an HSA An HSA is like a financial Swiss Army Knife. But while it’s highly versatile, it’s not the right choice for everyone. So, before you switch health plans and open an HSA, there are a few things to consider. Know the fees When it comes to fees and other costs, HSAs are often less transparent than accounts like 401(k)s. Look at the full fee schedule for your HSA before contributing. Also, sometimes your employer will cover all, or a portion, of your fees—so find out about that, too. Explore the investment options Ideally, you want an HSA with investment options that fit your goals. Some providers only allow investments with low risk and low returns, like money market funds. Other HSAs offer multiple mutual fund listings with higher returns and more risk exposure. Some HSAs have minimums before you can start investing. For example, you might only be able to invest your money once you’ve contributed $1,000 to the HSA. Stay current on withdrawal rules Withdrawal rules around taxes and penalties can change with new regulations, so it’s important to stay up-to-date with any new changes that take place. Don’t just switch to an HDHP A high-deductible health plan isn’t right for everyone. Before switching to an HDHP so you can use an HSA to save for retirement, make sure that works for you and your family. A high-deductible health plan brings with it the potential for higher out-of-pocket medical costs.

Backdoor Roths and beyond: The four camps who can benefit Roth IRA conversions can unlock serious savings, especially if you find yourself in one of these scenarios. Roth IRAs and their tax-free perks are pretty great—so great that in some scenarios, it can make sense to convert pre-tax dollars from traditional retirement accounts into post-tax dollars in a Roth IRA. This is what’s known as a Roth conversion. You’re effectively taking those pre-tax funds and telling Uncle Sam you’d rather pay taxes on them now in exchange for the benefit of tax-free and penalty-free withdrawals in retirement. And if you need the money earlier, the IRS requires only that you wait five years before withdrawing each conversion to avoid a 10% penalty. So who do Roth conversions appeal to in particular? Four types of people: High earners and the “backdoor” Roth conversion Recent retirees and unwelcome RMDs Early retirees and the Roth conversion “ladder” People experiencing temporary income dips High earners and the “backdoor” Roth conversion Did you know the IRS restricts access to Roth IRAs based on income? Shut the front door! Yes, if your income exceeds these eligibility limits, you can’t contribute directly to a Roth IRA. But as the saying goes, when one door closes, another door opens. A “backdoor,” more specifically. So if you make too much money, fear not – you can contribute indirectly to a Roth IRA via a Roth conversion widely known as a “backdoor” Roth. This entails contributing post-tax dollars first to a traditional IRA, then converting those funds to a Roth IRA. If you’ve never contributed to a traditional IRA before, pulling off a backdoor Roth can be simple, especially if you use Betterment. Open both a traditional and Roth IRA with us, fund the traditional, then convert those funds to your Roth IRA once they’ve settled. Done! If you have any existing traditional IRA funds, however, things get a little more complicated due to something called the pro rata rule. In short, you need to move any pre-tax dollars out of your traditional IRA(s) into an employer-sponsored retirement account like a 401(k) before you can use the account as a backdoor. This gets even more complicated if you have both pre- and post-tax dollars mixed together in your traditional IRA(s). Before going down the road of a backdoor Roth conversion, or any Roth conversion really, we highly recommend seeking the advice of a financial advisor, as well as a tax advisor in certain cases. They can help assess both your current situation and future projections. Recent retirees and unwelcome RMDs The IRS doesn’t let you keep funds in your traditional retirement accounts indefinitely. They’re meant to be spent, after all. So starting at age 73, annual required minimum distributions (RMDs) from these accounts kick in. RMDs aren’t inherently a bad thing, but if your expenses can already be covered from other sources, RMDs will just raise your tax bill unnecessarily. You can get ahead of this and lower your future amount of RMDs by converting traditional account funds to a Roth IRA before you reach RMD age. That’s because Roth IRAs are exempt from RMDs. And as an added benefit, you’ll minimize taxes on Social Security benefits and Medicare premiums later on in retirement. Just make sure you convert those funds before you turn 73, because once RMDs kick in, those amounts can’t be converted. Early retirees and the Roth conversion “ladder” If you want to retire early, even by “just” a few years, you very well might encounter a problem: Most of your retirement savings are tied up in tax-advantaged 401(k)s and IRAs, which slap you with a 10% penalty if you withdraw the funds before the age of 59 ½. A few exceptions to this early withdrawal rule exist, the biggest for early retirees being that contributions to a Roth IRA (i.e., not the gains you may see on those contributions) can be withdrawn early without taxes or penalties, in this specific order: “Regular” contributions made directly to a Roth IRA. As an aside, you can always withdraw these funds tax-free and penalty-free without waiting five years. Once you’ve burned through regular contributions, the IRS allows you to withdraw contributions that were converted from traditional 401(k)s and traditional IRAs! You won’t pay any additional taxes on these withdrawn contributions because taxes have already been paid. But withdrawn conversions (item #2 above) typically are still subject to a 10% penalty if withdrawn before 5 years. Think of this rule as a speed bump in an otherwise swift shortcut. So what does all of this mean for early retirees? Starting five years before they plan on retiring, they can create a “ladder” looking something like the table below (note: dollar amounts are hypothetical). They convert funds each year, pay taxes on them at that time, then withdraw them five years later 10% penalty-free and sans any additional taxes. Time Amount converted Amount withdrawn Source of withdrawal 5 years pre-retirement $40,000 $0 N/A 4 years pre-retirement $40,000 $0 N/A 3 years pre-retirement $40,000 $0 N/A 2 years pre-retirement $40,000 $0 N/A 1 year pre-retirement $40,000 $0 N/A Retired early! 🎉 Year 1 of retirement $40,000 $40,000 5 years pre-retirement Year 2 of retirement $40,000 $40,000 4 years pre-retirement Year 3 of retirement $40,000 $40,000 3 years pre-retirement Year 4 of retirement $40,000 $40,000 2 years pre-retirement Year 5 of retirement $40,000 $40,000 1 year pre-retirement Etc. Etc. Etc. Etc. People experiencing temporary income dips Say you find yourself staring at a significantly smaller income for the year. Maybe you lost your job. Maybe you work on commission and had a down year. Or maybe you had a big tax writeoff. Whatever the reason, that dip in income means you’re currently in a lower tax bracket, and it may be wise to pay taxes on some of your pre-tax investments now at that lower rate compared to the higher rate when your income bounces back. Watch out for potential Roth conversion pitfalls Each of these scenarios requires careful tax planning, so again, we recommend working with a trusted financial advisor and/or tax advisor. They can help you avoid the most common Roth conversion mistakes and take full advantage of this post-tax money maneuver. Our CERTIFIED FINANCIAL PLANNER™ professionals are here to offer on-demand guidance.

How To Manage Your Income In Retirement An income strategy during retirement can help make your portfolio last longer, while also easing potential tax burdens. Retirement planning doesn’t end when you retire. To have the retirement you’ve been dreaming of, you need to ensure your savings will last. And how much you withdraw each month isn’t all that matters. In this guide we’ll cover: Why changes in the market affect you differently in retirement How to help keep bad timing from ruining your retirement How to decide which accounts to withdraw from first How Betterment helps take the guesswork out of your retirement income Part of retirement planning involves thinking about your retirement budget. But whether you’re already retired or you’re simply thinking ahead, it’s also important to think about how you’ll manage your income in retirement. Retirement is a huge milestone. And reaching it changes how you have to think about taxes, your investments, and your income. For starters, changes in the market can seriously affect how long your money lasts. Why changes in the market affect you differently in retirement Stock markets can swing up or down at any time. They’re volatile. When you’re saving for a distant retirement, you usually don’t have to worry as much about temporary dips. But during retirement, market volatility can have a dramatic effect on your savings. An investment account is a collection of individual assets. When you make a withdrawal from your retirement account, you’re selling off assets to equal the amount you want to withdraw. So say the market is going through a temporary dip. Since you’re retired, you have to continue making withdrawals in order to maintain your income. During the dip, your investment assets may have less value, so you have to sell more of them to equal the same amount of money. When the market goes back up, you have fewer assets that benefit from the rebound. The opposite is true, too. When the market is up, you don’t have to sell as many of your assets to maintain your income. There will always be good years and bad years in the market. How your withdrawals line up with the market’s volatility is called the “sequence of returns.” Unfortunately, you can’t control it. In many ways, it’s the luck of the withdrawal. Still, there are ways to help decrease the potential impact of a bad sequence of returns. How to keep bad timing from ruining your retirement The last thing you want is to retire and then lose your savings to market volatility. So you’ll want to take some steps to try and protect your retirement from a bad sequence of returns. Adjust your level of risk As you near or enter retirement, it’s likely time to start cranking down your stock-to-bond allocation. Invest too heavily in stocks, and your retirement savings could tank right when you need them. Betterment generally recommends turning down your ratio to about 56% stocks in early retirement, then gradually decreasing to about 30% toward the end of retirement. Rebalance your portfolio During retirement, the two most common cash flows in/out of your investment accounts will likely be dividends you earn and withdrawals you make. If you’re strategic, you can use these cash flows as opportunities to rebalance your portfolio. For example, if stocks are down at the moment, you likely want to withdraw from your bonds instead. This can help prevent you from selling stocks at a loss. Alternatively, if stocks are rallying, you may want to reinvest your dividends into bonds (instead of cashing them out) in order to bring your portfolio back into balance with your preferred ratio of stocks to bonds. Keep an emergency fund Even in retirement, it’s important to have an emergency fund. If you keep a separate account in your portfolio with enough money to cover three to six months of expenses, you can likely cushion—or ride out altogether—the blow of a bad sequence of returns. Supplement your income Hopefully, you’ll have enough retirement savings to produce a steady income from withdrawals. But it’s nice to have other income sources, too, to minimize your reliance on investment withdrawals in the first place. Social Security might be enough—although a pandemic or other disaster can deplete these funds faster than expected. Maybe you have a pension you can withdraw from, too. Or a part-time job. Or rental properties. Along with the other precautions above, these additional income sources can help counter bad returns early in retirement. While you can’t control your sequence of returns, you can control the order you withdraw from your accounts. And that’s important, too. How to decide which accounts to withdraw from first In retirement, taxes are usually one of your biggest expenses. They’re right up there with healthcare costs. When it comes to your retirement savings, there are three “tax pools” your accounts can fall under: Taxable accounts: individual accounts, joint accounts, and trusts. Tax-deferred accounts: individual retirement accounts (IRAs), 401(k)s, 403(b)s, and Thrift Savings Plans Tax-free accounts: Roth IRAs, Roth 401(k)s Each of these account types (taxable, tax-deferred, and tax-free) are taxed differently—and that’s important to understand when you start making withdrawals. When you have funds in all three tax pools, this is known as “tax diversification.” This strategy can create some unique opportunities for managing your retirement income. For example, when you withdraw from your taxable accounts, you only pay taxes on the capital gains, not the full amount you withdraw. With a tax-deferred account like a Traditional 401(k), you usually pay taxes on the full amount you withdraw, so with each withdrawal, taxes take more away from your portfolio’s future earning potential. Since you don’t have to pay taxes on withdrawals from your tax-free accounts, it’s typically best to save these for last. You want as much tax-free money as possible, right? So, while we’re not a tax advisor, and none of this information should be considered advice for your specific situation, the ideal withdrawal order generally-speaking is: Taxable accounts Tax-deferred accounts Tax-free accounts But there are a few exceptions. Incorporating minimum distributions Once you reach a certain age, you must generally begin taking required minimum distributions (RMDs) from your tax-deferred accounts. Failure to do so results in a steep penalty on the amount you were supposed to take. This changes things—but only slightly. At this point, you may want to consider following a new order: Withdraw your RMDs. If you still need more, then pull from taxable accounts. When there’s nothing left in those, start withdrawing from your tax-deferred accounts. Pull money from tax-free accounts. Smoothing out bumps in your tax bracket In retirement, you’ll likely have multiple sources of non-investment income, coming from Social Security, defined benefit pensions, rental income, part-time work, and/or RMDs. Since these income streams vary from year to year, your tax bracket may fluctuate throughout retirement. With a little extra planning, you can sometimes use these fluctuations to your advantage. For years where you’re in a lower bracket than usual–say, if you’re retiring before you plan on claiming Social Security benefits–it may make sense to fill these low brackets with withdrawals from tax-deferred accounts before touching your taxable accounts, and possibly consider Roth conversions. For years where you’re in a higher tax bracket, like if you sell a home and end up with large capital gains–it may make sense to pull from tax-free accounts first to minimize the effect of higher tax rates. Remember, higher taxes mean larger withdrawals and less money staying invested.