HSAs and Retirement: Understanding How RMDs Affect Retirement Tax Planning

By William G. Stuart | Originally posted on LinkedIn for MaxHSA

How you save for retirement affects your income and tax planning later in life. Health Savings Accounts can help you maintain greater control.

Many Americans diligently saving for retirement in tax-deferred accounts have no idea that they have a silent ownership partner. The federal government is not listed as a co-owner of the account (in fact, by law, these accounts appear to be individually owned, therefore no "spousal" or "family" retirement accounts). The federal government does have power of some aspects of these plans.

One such aspect is the timing of distributions. This silent partner determines when you must begin to withdraw funds from your tax-deferred retirement account. Whether you need the money that year or not.

Let's examine this issue and see how the favorable treatment of Health Savings Accounts gives account owners control over when and how much they distribute from their accounts.

Note: This is Part 2 of a three-part series about the benefits of incorporating Health Savings Accounts into retirement planning and funding. Last week, we focused on Required Minimum Distributions and whether this requirement extends to Health Savings Accounts. Next week, we discuss taxation of Social Security benefits and how Health Savings Accounts may help owners close to certain income thresholds reduce taxes on their Social Security checks.

Defining Required Minimum Distributions

When you save for retirement in tax-deferred Individual Retirement Arrangements (IRAs) and employer-sponsored retirement plans (like 401(k), 403(b), and similar vehicles), you enjoy immediate tax savings when they contribute. Your contributions are not included in your federal or state taxable income. You do pay payroll taxes (15.3% of your income up to $184,500, split evenly between you and your employer).

Example: You want to reduce current consumption by $1,000 to fund a retirement account. You avoid income taxes but pay your share of payroll taxes. You thus contribute $923.50 ($1,000 less your $76.50 portion of payroll taxes due).

You then invest your balances and defer taxes on the gains. You pay taxes only when you withdraw funds from a tax-deferred account. This arrangement allows you to contribute more during your working years and build larger balances over decades of investment growth. The downside is that when you pay taxes as a senior, those taxes are applied to much higher balance. Think of it this way: Tax-deferred investors pay the tax on the harvest, which is many times the value of the seeds that they planted decades ago.