HSAs For Retirement: A Savings Booster Shot

By Justin Pritchard, CFP®

If you’re serious about saving for retirement and minimizing taxes, Health Savings Accounts (HSAs) may be able to help you with those goals. Although HSAs are primarily designed for healthcare, they can provide a powerful boost to your retirement savings.

HSAs for Current Healthcare Needs?

You can spend funds from your HSA at any time. As long as you use the money for qualified healthcare expenses (as defined by the IRS), the money comes out tax-free. The idea is to help make healthcare more affordable, and even encourage you to take a more active role in shopping healthcare providers.

It’s not necessarily a bad idea to pay for your next (qualified) healthcare expense out of your HSA. But you don’t have to spend that money—you can leave it in your HSA for future needs.

Use it or lose it? HSAs do not have a “use it or lose it” feature like flexible spending accounts (FSAs). You can leave your money invested and continue contributing to the account as long as you’re eligible. You’ll almost certainly have healthcare expenses year after year, but nothing is stopping you from just paying those expenses out of your cash flow or your savings account.

Using HSAs as Retirement Accounts

By paying expenses without tapping your HSA, the account has an opportunity to grow. If things work out well, you’ll have a substantial amount available for retirement needs or an unexpected health crisis (which will hopefully never materialize). Your account can grow in two ways:

  • Keep contributing: As long as you’re eligible, you can keep adding to the account, year after year, while paying annual healthcare expenses out of cash flow.
  • Investment growth: Depending on the investments you use, your account might also grow with interest payments, dividends, and market movements. Of course, if you’re in risky investments, it’s also possible to lose money.

Unfortunately, you’re not getting any younger—nobody is—and healthcare costs tend to rise as we age. There’s a good chance that you’ll need those funds in the future, and the more you have tucked away, the better.

What about Medicare? Medicare doesn’t pay for everything in retirement. In addition to paying Medicare premiums, you’ll have plenty of other expenses. Indeed, the U.S. Department of Health and Human Services explains that “Services like dental and vision care are Qualified Medical Expenses, but aren’t covered by Medicare.” Certain copays and other expenses may also be qualified expenses.

Other retirement accounts: Hopefully, you’re already using retirement accounts like IRAs and employer-sponsored retirement plans. Using an HSA for healthcare costs in retirement may be a logical next step if you max out those accounts.

Spending Your HSA Savings in Retirement

The rules on spending your money can get complicated. Always ask a tax professional for guidance before you make decisions (I’m happy to provide names of local CPAs). That said, here are some ideas to discuss with your CPA:

A family affair: HSA assets can cover qualified expenses for you, your spouse, and dependents you claim on your tax return. That may help to convince you that you’ll have no problem spending that money in retirement.

Qualified expenses: To receive tax-free distributions from an HSA, you need to spend money on “qualified” medical expenses defined by the IRS. That category contains numerous items, including Medicare premiums as well as other costs mentioned above. For complete details, visit IRS.gov.

Saving receipts: You don’t necessarily have to take a withdrawal from your account and reimburse yourself in the same year you face expenses. You can even wait until retirement to tap your HSA and justify those distributions with qualified expenses that you paid (and have proof of) in previous years. Waiting for more than a short time can cause problems (including the need to keep records indefinitely—and the fact that receipts may fade over time), but some people like that strategy. No matter how you spend, it’s essential to keep accurate records of your qualified expenses.

If you save too much: Although unlikely, it’s possible that you’ll accumulate too much money. If that happens, you can withdraw the money and spend it on other things (besides qualified medical expenses). Doing so will result in income tax liability similar to taking funds from your traditional IRA. If you’re under age 65 when you take the distribution, you may also have to pay an additional penalty tax—so consider using other sources first. Earmarking your HSA for retirement can either supplement your existing pre-tax savings (if you save “too much”), or it can provide triple-tax-free assets for healthcare.

HSA Basics

HSAs feature tax benefits for individuals who pay healthcare costs. The highlights are:

  • Money goes into the account pre-tax, reducing your taxable income in the year you contribute.
  • Earnings in the account (interest, dividends, etc.) are shielded from annual taxation.
  • You can take tax-free withdrawals for healthcare expenses—as long as you follow IRS rules.

Spending rules: As with any account that provides tax benefits, there are also restrictions on how you use the account. If you spend money from an HSA on anything besides “qualified” medical expenses, you’ll owe income tax on those distributions. Depending on your age, you may also have to pay additional penalty taxes.

Health insurance coverage: You need to be eligible to make contributions to an HSA, which you satisfy by enrolling in a high-deductible health plan (HDHP) and meeting other IRS criteria. That health insurance coverage can come from your employer, or it can be an individual plan you purchase on your own. If you’re not sure what type of plan you have, ask your health insurance provider or your employer. You may have several options available, and it may be possible to switch to an HDHP if you’re not currently using one.

Investment options: HSAs offer a variety of options. If you prefer to keep your money safe, you can use a bank or credit union for HSA savings. If you are willing and able to take more risk, you can use other investments like mutual funds.

Employer contributions:  Your employer can add money to your HSA, which helps you accumulate significant savings. That money is yours once it’s in the account—there is no requirement to use that employer money, and there’s no vesting schedule to worry about if you change jobs.

Adding Money to an HSA

You’ll need to be disciplined to build up enough savings to make your HSA meaningful in retirement. Annual contribution limits are relatively low, especially when compared to other retirement accounts, but every little bit counts.

Without getting too technical, here are a few tips that may help you build a retirement-ready HSA:

Income limits: You don’t need earned income to contribute to an HSA (this is a requirement with some other accounts), making them a decent option for early retirees and others who are between jobs. Also, there is no maximum income limit, which means that anybody who is eligible to contribute can make pre-tax contributions.

Last-month rule: If you’re not currently using an HSA but you want to beef up your retirement savings, see if the last-month rule can help. By switching to an HSA late in the year, you might be eligible to make the full annual contribution—but verify your situation with a tax professional before you do anything.

Medicare time: Once you enroll in Medicare, you can no longer make HSA contributions. However, you can still take tax-free withdrawals for qualified medical expenses.

HSA Contribution limits:

For 2022:

  • Self-only: $3,650
  • Family: $7,300

For 2023:

  • Self-only: $3,850
  • Family: $7,750

Catch-up contribution (age 55 and older—not age 50): $1,000