Health savings accounts (HSAs) help you set aside money to pay for qualified medical expenses, but did you know they can also be a great tool for retirement planning? You can invest money stashed in an HSA in mutual funds and stocks, plus it offers valuable tax benefits—all of which make health savings accounts an ideal way to save up for inevitable medical expenses in retirement.
Retirement Planning with HSAs
High-deductible health plans (HDHPs) can be an expensive option for health insurance coverage, due to elevated out-of-pocket costs. That’s why they generally offer health savings accounts, which can help you cover some of the extra medical costs associated with HDHPs.
An HSA offers a hat trick of tax advantages: Contributions to your account are made pre-tax, lowering your taxable income today; investments grow tax free while they’re kept in the account; and withdrawals are free of income tax, as long as you use the money for qualified medical expenses.
Sound familiar? These advantages might remind you of the benefits you get with retirement plans like a 401(k) or an individual retirement account (IRA)—but they’re even better with an HSA, if you use it correctly.
“You aren’t taxed on either end if HSA withdrawals are qualified. It combines the best tax features of a Roth and a tax-deferred account,” says Brandon Renfro, a certified financial planner (CFP) and assistant professor of finance at East Texas Baptist University.
And like retirement plans, HSAs also let you invest your savings in mutual funds, stocks, exchange traded funds (ETFs) and other securities—which offer better growth potential than a regular savings account.
HSAs vs FSAs
Health plans with lower deductibles—and lower out-of-pocket costs—offer flexible spending accounts (FSAs). They offer similar tax advantages to an HSA, but with an FSA, you have to use the money or lose the money by the end of each year. You can’t roll over the funds. Not so with HSAs: You get the tax benefits and you can maintain a balance indefinitely.
Making regular contributions to an HSA with an eye toward covering medical expenses later in life should be a key part of your retirement plan. Fidelity has estimated a couple retiring in 2020 would need almost $300,000 to cover medical costs in their golden years. And this number will only rise over time as medical costs routinely outpace inflation by multiples.
Best of all, after you turn 65 you can use the funds for any purpose above and beyond medical expenses if you pay income taxes on the withdrawals. Before you turn 65, though, you must pay income taxes plus a 20% penalty on unqualified withdrawals.
How to Save for Retirement with Your HSA
If you choose to use your HSA to save for retirement, follow these tips to ensure you’re getting the most out of your account.
Reserve Enough Cash to Cover Your Deductibles
Since HSAs are only available with high-deductible health plans, you need to make sure you have enough cash on hand to pay your higher deductibles when you need medical care. Save the money in your HSA or in a high-yield savings account.
If you choose to keep funds earmarked for deductibles in your HSA, make sure it isn’t invested in tradable securities.
During a market downturn, you might be forced to sell shares of any mutual funds or stocks you own at a loss in order to pay for medical care.
If you’re especially concerned about covering medical costs in a pinch, consider raising the amount you keep liquid to be equal to your out-of-pocket maximum.
Invest the Extra Funds
Once you have enough liquid cash to cover your deductibles, invest the rest of your HSA funds. Unfortunately, most people with HSAs—including those who report they’re saving for retirement with an HSA—do not invest in stocks, bonds or mutual funds using their account, according to the Employee Benefit Research Institute (EBRI).
Your HSA provider may provide you with a range of different funds and securities as options. If you don’t like what you see, consider moving your funds to a provider with better choices. As long as you have an HDHP, you can open an HSA outside of the one your employer provides.
As with all retirement investing, carefully consider your time horizon. The number of years standing between you and retirement will likely dictate how aggressive or conservative you choose to be in your fund selection. If you’re looking for a hands-off approach, consider a target-date fund.
Save Your Medical Receipts
If you’re using your HSA to invest for retirement, you might choose not to use the funds to pay for medical expenses now. But it’s still important to track medical expenses now because they may help you make tax-free withdrawals from your HSA later.
HSAs have no clock on medical reimbursements, meaning if you have a saved receipt, you can pay yourself back for it even years after the initial expense.
“If your child had an emergency room visit years ago, you may reimburse yourself at any time from the HSA, as long as you have the receipt,” says Paul Mitchell, CFP and partner of Precision Wealth Partners in Delaware. “You can choose to pay all medical bills out of pocket, invest the HSA funds, then reimburse later with the HSA earnings from any tax-favored growth.”
Make Catch-up Contributions
Like other tax-advantaged retirement accounts, HSAs allow catch-up contributions as you approach retirement age. With an HSA, you can invest an extra $1,000 per year if you are 55 or older,. This brings HSA contribution maxes to $4,600 for an individual and $8,200 for a family.
Consider an IRA Rollover
If you have money in a traditional IRA, you can make a one-time transfer of funds into a health savings account through a process known as a rollover. It gives some of your IRA funds the triple-tax-free benefits of an HSA, assuming you used the money for current or past health-related expenses. If you used them in any other way, you would effectively have a traditional IRA by another name.
A few important notes about an IRA-HSA rollover:
- You are able to do this one time in your life.
- You must remain in a HDHP for 12 months after this rollover takes place.
- You are limited to rolling over no more than your annual single or family contribution max for the year, minus any money you’ve already contributed to your HSA that year. In other words, your IRA rollover is less a rollover and more making your HSA contribution for the year with your retirement account, instead of your wallet.
With that in mind, it would generally only make sense to do this kind of rollover if you cannot or were not planning on maxing out your HSA in a given year. From a retirement planning perspective, it would be better to contribute as much as you can to both an HSA and an IRA to benefit from all of the tax advantages you can.
Save What You Can Before Medicare
When you’re no longer in a HDHP, you cannot contribute to an HSA. This means that once you’ve started taking Medicare, you can no longer contribute to an HSA, even through an IRA rollover.
How to Use Your HSA in Retirement
Once you’ve retired, you can use your health savings account in quite a few ways—including some that have nothing to do with health-related expenses.
- Pay your retirement healthcare bills. Medical expenses are big part of retirement costs. At a bare minimum, you may be responsible for Medicare Part A and B premiums, prescriptions and out-of-pocket costs, like deductibles.
- Bridge the gap to Medicare. You can only join Medicare when you turn 65 (unless you qualify due to a disability). If you end up retiring before then, your HSA funds are particularly well suited to covering your healthcare bills, which can include insurance premiums, until you qualify for government support.
- Cover non-medical expenses. After you turn 65, you can start using your HSA for non-healthcare expenses, as the 20% early withdrawal penalty no longer applies. Use it to cover your day-to-day expenses or pay for home renovations. You’ll simply owe income taxes on whatever you withdraw.
- Prepare for long-term care expenses. Long-term care is expensive, with a private room in a nursing home potentially costing over $90,000 a year, according to the U.S. Department of Health & Human Services. Because Medicare generally does not cover long-term care, an HSA provides insurance should you need it.
- Leave an inheritance to your spouse. If you pass away without spending down your HSA, your spouse can inherit the account and turn it into their own HSA, keeping the same tax benefits on the savings. That way you can help them cover their retirement medical bills as well. Non-spouse heirs can inherit an HSA, too, but they’ll owe tax on the entire HSA balance right away.
Health Savings Account FAQs
What Is an HSA?
An HSA is a type of savings account you can use to put money aside for eligible expenses like medical bills, deductibles and copayments from your health insurance plan, dental and vision care, prescriptions and medical supplies.
To help you save money, these accounts over several tax breaks:
- You can deduct your HSA contributions from your taxable income today.
- Money in your HSA grows tax free as long as it stays in the account, like with a traditional IRA.
- Money can be withdrawn tax free as long as it’s used to cover HSA eligible expenses, similar to an FSA. Unlike FSAs, however, HSAs have no deadline before which you must spend money in your account.
HSA Account Rules
Unlike FSAs, not everyone can open and fund an HSA. To use an HSA, you must be enrolled in a high deductible health plan (HDHP). This is a health plan with a deductible of at least $1,400 for an individual or $2,800 for a family. Out-of-pocket expense maximums can be no higher than $7,000 for an individual and $14,000 for a family.
In exchange for taking on this high of a deductible, an HDHP entitles you to put away up to $3,600 a year into an HSA as an individual or $7,200 as a family. If you are 55 or older, you can contribute an extra $1,000 to each of those totals.
You have until Tax Day, generally April 15 of the following year, to make HSA contributions for the previous year. If you contribute to an HSA in a given tax year, you will not be able to also make contributions to a general FSA that year. You may be entitled to make contributions to a limited-purpose FSA, which is restricted to covering expenses for vision and dental care.
If you put money into an HSA, you can make tax-free withdrawals at any time to fund qualified medical expenses. If you spend HSA dollars on ineligible expenses, you’ll owe income tax plus a 20% penalty on the withdrawal. This means you are penalized twice as much when for early unauthorized withdrawals from an HSA as you would from any kind of tax-advantaged retirement account.
That said, once you turn 65, you can make penalty-free (but not tax-free) withdrawals for any reason. This in effect converts your HSA into a traditional IRA, though any money spent on medical expenses remains tax free.
Should You Use Your HSA to Save for Retirement?
If the rest of your financial house is in order, meaning you’ve got a sufficient emergency fund and are contributing at least enough to get any employer match to your 401(k) or 403(b), “it may make sense to put some retirement dollars into an HSA,” says Mitchell. “Generally, we like to see at least 15% of someone’s gross salary saved for retirement, and an HSA may be a great option for a part of this.”