Summary:
Yes. HSA funds can be used tax and penalty-free to pay COBRA premiums, but not marketplace health insurance premiums. That means for anyone retiring early, it’s worth looking at the numbers behind using HSA funds to pay for COBRA first, before moving on to a marketplace plan. This can protect the funds you’re using to support the first phase of your early retirement before you can fully access the rest of your accounts at 59.5. Here’s how all this works.
Health Insurance Is One of the Largest Costs in Early Retirement
Most early retirement strategies focus on overall costs and safe withdrawal rates relative to the portfolio. Healthcare is typically one of the largest components of those expenses. However, our experience is that very few early retirees accurately model healthcare expenses or even develop an approach to tackling these costs until well after they’ve left their corporate jobs. Planning out an approach before you leave your job can protect your core cashflows until full retirement benefits kick in.
The key is using your HSA as a bridge fund to pay for premiums. But it’s important to know which premiums can be paid with your HSA.
Can you use HSA funds to pay for COBRA premiums?
Yes. The IRS explicitly allows HSA funds to be withdrawn tax and penalty-free to pay COBRA premiums. This is one of the few premium types HSAs are allowed to cover before full retirement benefits. We’ll get to why this matters in a moment.
Can you Use HSA funds to pay for marketplace premiums?
No. Marketplace (ACA exchange) premiums are explicitly excluded from the list of HSA-qualified expenses. There is one exception: if you’re receiving federal or state unemployment compensation, marketplace premiums can qualify.
Outside of that exception, if you try to go straight to a marketplace plan pay for it with HSA funds, you’ll owe income tax on the withdrawal, plus a 20% penalty if you’re under 65.
How HSA-funded premiums affect early retirement
If you’re retiring before 59.5, you’re likely relying on funds in your savings, taxable brokerage, and Roth accounts in the early years. The less you need to tap into these early on, the more assets you’ll have to carry you to full retirement age where you’ll unlock the rest of your accounts (401k, IRA, etc.).
Let’s say you retire early at 45 in April.
You already made too much this year in earned income and your expected passive income to qualify for marketplace subsidies so you would have to pay full price for a plan. The plan you’re looking at is $1,850 a month without these subsidies.
Your COBRA plan also costs you $1,850 a month. You can use this plan for the next 8 months until the start of the following calendar year when you can take advantage of marketplace subsidies.
$1,850 a month * 8 months = $14,800 in premiums for the rest of the year
If you’re following the 4% safe withdrawal guidelines for typical early retirement budgeting, paying these premiums out of the accounts you’re using to support your early retirement would reduce your withdrawal rate by:
4% * $14,800 = ~$592 a year
While that’s not a huge number, every bit helps in the first stages of early retirement. The loss of that $14,800 in assets used to support your day to day living is an immediate and permanent loss of $592 in potential funds you can pull from your accounts. Ouch.
What else you need to look at
This was a simplified example to show the primary reason why an early retiree would consider COBRA over Marketplace if they have available HSA funds to utilize.
When we help clients with this decision, we look at other factors like:
- How pulling funds from the HSA will reduce the tax-deferred compounding of the account. You need to weigh the tradeoffs of doing this vs. the amount of liquidity you want available to you for early retirement.
- How much of a subsidy someone qualifies for and where their income will be for the calendar year
- The net cost of the marketplace plans they’re considering vs. the net cost of their COBRA options
If you liked this piece, you should check out:
- What Worked: 9 Things That Made Me Financially Independent Before 40
- Leaving a C-Level Corporate Career
We specialize in all things early retirement. If you want help modeling out how to approach healthcare in early retirement, reach out to me at the email below.
Nathan
Founder & Lead Advisor
[email protected]
The Tradeoff
Most financial advice is generic. Mine isn’t. Get an email every other week with real strategies and stories from my work with mid-career professionals. Free, no paywall.
Kangpan & Co. is a flat-fee financial advisory firm specializing in helping mid-career professionals navigate the career, family, and financial tradeoffs that come with this stage of life. This content is for educational purposes only and is not financial, legal, or tax advice. Consult a licensed advisor for help with your individual situation. Employees and clients of Kangpan & Co. may hold positions discussed in our content. Past performance is no guarantee of future results.