How to Use Your HSA to Save for Retirement

The Health Retirement Account You May Not Know About

Paying at drugstore with HSA card.
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Health savings accounts (HSAs) provide a tax-advantaged means of saving for health care costs, just as the name suggests. While you might think of an HSA as a way to save and pay for current medical expenses, an HSA is an excellent way to save for retirement as well.

Because you can invest the money in an HSA, you can take advantage of compound returns to accumulate a tax-advantaged pool of money to pay for health care tax-free in retirement.

Let’s look at how an HSA can provide you with substantial benefits as a retirement account.

What Is a Health Savings Account?

An HSA is an account that you can deposit money into for the express purpose of saving for medical expenses. You get to deduct contributions to an HSA just like you would contributions to a 401(k) or IRA. A key difference here, though, is that you can also withdraw the money tax-free as long as you use it to pay for qualified medical expenses.

The IRS imposes an annual limit on the amount you can deposit into your account: $3,600 for an individual and $7,200 for a family in 2021. Any contributions you make above the annual limit could incur a 6% tax. 

HSAs are distinct from flexible spending arrangements (FSAs), so be careful not to confuse the two. A key difference is that unlike the money in an HSA, you can’t keep the money left in your FSA at the end of the year. That means that FSAs don’t provide the same potential as a retirement savings tool that HSAs do.

How an HSA Can Help You in Retirement

You can use an HSA as a retirement savings vehicle by investing your contributions and withdrawing money for qualified medical expenses in retirement. When you treat your HSA this way you benefit from what’s known as a “triple tax advantage”:

  • You get to deduct contributions, up to the current IRS limit, from your income. 
  • Your earnings grow tax-free; you won’t owe any taxes on the dividends, interest, or capital gains inside the HSA. 
  • Any withdrawals to pay for qualified medical expenses in retirement are also tax-free.

What Are Qualified Medical Expenses?

Generally, any expenses that qualify for the medical and dental expenses deduction outlined in IRS Pub. 502 are “qualified expenses.” The qualified expenses list encompasses more than 75 expenses and includes medical, dental, vision, and certain medications.

You can also “save” qualified medical expenses to claim later in retirement. For example, if you buy a pair of eyeglasses when you are 55, you can wait and take the withdrawal after you retire. Whether or not you should is a matter of your own tax plan and strategy, but it gives you another planning tool.

Can I Open an HSA?

You can open an HSA on your own, or through an employer if your employer offers one.

However, not everyone is eligible to open an HSA. To be able to open an HSA, you must be covered by a high-deductible health plan (HDHP), you can’t have other health insurance coverage, you aren’t a dependent on someone else’s taxes, and you aren’t enrolled in Medicare.

An HDHP is defined by the deductible and out-of-pocket expenses. The amounts change each year, and for 2021, an HDHP is one for which the annual deductible is at least $1,400 for individual coverage and $2,800 for family coverage. The out-of-pocket limits cannot exceed $7,000 for an individual or $14,000 for family coverage.

Rules for Using Your HSA in Retirement

As with any tax-advantaged plan, there are rules that dictate when and how you can use the money in your HSA. 

As long as you use the money to pay for qualified medical expenses, then you won’t owe any taxes at all on a distribution—regardless of when you take it. But what if you withdraw the money to pay for things other than qualified medical expenses? 

If you are under 65, the IRS taxes the distribution as ordinary income and you may owe a 20% penalty. Once you turn 65, you’ll no longer have to pay a 20% penalty. At that point, your HSA effectively functions like an IRA, except that you can take tax-free distributions to pay for qualified medical expenses.

Particularly beneficial for retirees, an HSA allows you to take tax-free withdrawals to pay for Medicare premiums, except for Medicare supplemental policy premiums. However, once you start Medicare, you are no longer eligible to contribute additional money into your HSA.

Unlike an IRA or 401(k), you don’t have to take required minimum distributions (RMDs) from an HSA.

HSA vs. HRA

A Health Reimbursement Arrangement (HRA) is another type of account that is similar to an HSA. However, only your employer contributes to an HRA and HRAs cannot move with you to a new employer.

This table highlights a few of the key differences between an HSA and HRA:

HSA HRA
If you switch employers, you can take it with you If you switch employers, you lose it
The employee and employer can make contributions Contributions come from employer only
HDHP coverage required HDHP coverage not required
Contributions limits set by IRS Contribution limits set by employer

How an HSA Might Beat Your 401(k)

Although we typically think of retirement accounts like 401(k)s as the primary source of money in retirement, there are two main ways an HSA can provide even better benefits as a retirement account. 

  1. An HSA gives you a triple tax advantage. A 401(k) is either pre-tax or after-tax, so you’ll have to pay taxes going in or coming out.
  2. HSAs do not require RMDs. You can continue to let your account grow even after you would otherwise have to start taking RMDs from a 401(k). This gives you more flexibility and control.

Keep in mind, though, that an HSA is not meant to replace a 401(k), as you can use your 401(k) withdrawals for more than just the medical expenses an HSA limits you to. By using both a 401(k) and an HSA, you can save the maximum amount to each.

Key Takeaways

  • HSAs allow you to save money for qualified medical expenses completely tax-free.
  • Withdrawals to pay for things other than qualified medical expenses are taxed at your income tax rate.
  • You can allow the earnings to accumulate, unlike an FSA, which is “use-it-or-lose-it."
  • You can wait until retirement to reimburse yourself for qualified medical expenses, giving you a tax-free source of income in retirement.
  • HSAs can be used in addition to retirement accounts such as 401(k)s.

Article Sources

  1. Internal Revenue Service. "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans." Page 8. Accessed Oct. 22, 2020.

  2. Internal Revenue Service. "26 CFR 601.602: Tax Forms and Instructions." Page 1. Accessed Oct. 22, 2020.

  3. Internal Revenue Service. "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans." Page 10. Accessed Oct. 22, 2020.