Congratulations. You landed that great job after your federal retirement. Your new challenge? How to drive down your taxable income.
The 2017 Tax Cuts and Jobs Act (TCJA) may have consequences, especially for higher-income earners in certain states. The TCJA capped the deduction for state and local taxes (SALT) at $10,000 a year. And what if the children finally left the nest? So did their tax deductions and credits. And what if you will be renting because the new job is not where you ultimately may want to live when you finally really retire? Or perhaps you have already paid off the mortgage on your home? That means no deduction for mortgage interest.
Consider the case where you have a FERS annuity and a new job with a generous salary. Maxing out 401k contributions in a second career to lower income tax is a good start. Federal annuitants in a second career, however, can no longer use their federal Health Care Flexible Spending Accounts (HCFSA). Federal annuitants who continue to use their FEHB coverage may be eligible for the new employer’s Limited Purpose Flexible Spending Account (LPFSA). LPFSAs in a private sector job like HCFSA can leverage pre-tax dollars to pay for qualified out-ot-pocket health care expenses.
High Deductive Health Plans (HDHP)
Federal retirees who decide to work may overlook an important opportunity available within their FEHB coverage. To really drive down your taxable income, it may be time to explore a FEHB High Deductible Health Plan (HDHP). HDHP plans may not be suitable if you have a chronic condition or need expensive medications. An individual in such a plan can contribute up to $7,200 or $14,400 if married in 2021 with an additional $1,000 for each person over age 55 in a Health Savings Account (HSA).
Health Savings Account (HSA)
HSAs are popular because of their relationship with taxes. Contributions are made with pre-tax dollars. There is tax-free compounding for the accounts and the withdrawals can be tax-free. At the end of 2020 there was over $82 million in more than 30 million HSA accounts with an average balance of $17,926.
You must be enrolled in a qualified HDHP for the time which contributions are made to the HSA. The money in the HSA can travel with you when you change jobs or retire. There is no time limit to spend the money for qualified health care expenses. The entire HSA balance, unlike only $550 of unused funds in a Flexible Spending Account (FSA), rolls over into the next year. The HSA funds therefore can accumulate into a significant amount if not used. HSA accounts unlike FSA account remain with you beyond employment.
At age 65, if you enroll in Medicare, you can no longer contribute to an HSA, but the funds are still available tax-free if used for out-of-pocket medical expenses. HSA funds can be used to pay for Medicare part B premiums. The funds cannot, however, be used to pay for Medigap policies or Medicare supplemental policies.
An HSA like an FSA account can only be used for expenses related to medical, dental, and vision care. HSA and FSA accounts can pay for medical deductibles, copayments, prescriptions, chiropractic care, hearing aids, eyeglasses or contact lenses. HSA accounts, unlike FSA accounts, do not have to be used or lost each year. An HSA account therefore can be available for home improvements years after retirement from a second career for needs such as widening a doorway or adding a ramp to make accessibility for someone in a wheelchair. Long term care premiums are among some of the other IRS-approved HSA eligible uses.
Also, you do not need to wait for a second career offer to have an HDHP with an HSA. The Office of Personnel Management’s website has detailed information to assist you in determining if shifting during from your current FEHB plan an HDHP with an HSA during Open Season. The OPM website also has a slide presentation, Understanding High Deductible Health Plans, and the Role of Health Savings Accounts Health Reimbursement Arrangements.
Francis Xavier (FX) Bergmeister, CFP®, CLU®, ChFC®, CASL®, ChSNC® is a graduate of the Wharton School. His graduate work includes a Doctor of Arts from George Mason University. He is a retired U.S. Marine Colonel and FBI Analyst. He provides seminars to federal employees and is the owner of Semper Why, LLC.