How To Use Your HSA To Save for Retirement

Health savings accounts (HSAs) provide a tax-advantaged means of saving for health care costs. 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. That's because the money in an HSA can be invested and grow, leading to a tax-advantaged pool of money to pay for health care tax-free in retirement. And after age 65, the account functions more like an IRA, so you can use the money for whatever you want, you'll just pay income tax on the withdrawals.

How an HSA Can Help You in Retirement

A health savings account (HSA) is an account in which you can deposit pre-tax money for the express purpose of saving for medical expenses. You can deduct contributions to an HSA just like contributions to a 401(k) or IRA. However, a key difference 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. For tax year 2023, the amount is $3,850 for individuals and $7,750 for families. For tax year 2022, the amount was $3,650 for an individual and $7,300 for a family. Any contributions you make above the annual limit could incur a 6% tax.

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.” Here's how that works:

• 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
• Other withdrawals after age 65 can be put toward other expenses, you'll just pay income tax on them first

What Are Qualified Medical Expenses?

There are more than 75 qualified medical expenses which include medical, dental, and vision expenses, and certain medications. You can also use HSA funds for some over-the-counter medicine, hospital expenses, and more.

When using an HSA to cover medical expenses, you must establish your account before incurring the expense to be considered qualified. And if using a rollover HSA, the established date will be the date of the original HSA.

Rules for Using Your HSA in Retirement

As with any tax-advantaged plan, some rules 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 to your HSA.

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: Even though contributions to a 401(k) are pre-tax, the deductions will be considered taxable income.
2. HSAs do not require RMDs: You can continue to let your HSA grow even after you would otherwise have to start taking RMDs from a 401(k). This gives you more flexibility and control.

Remember 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 that an HSA limits you to. By using both a 401(k) and an HSA, you can save the maximum amount for health and other retirement expenses.

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 an HRA:

Opening 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, the following requirements must be met:

• You need to be enrolled in a high-deductible health plan (HDHP)
• You can't be claimed as a dependent on someone else's tax returns
• You cannot be enrolled in Medicare
• You have no other form of health coverage

An HDHP is defined by the deductible and out-of-pocket expenses. The amounts change each year. For tax year 2023, the HDHP annual deductible must be at least $1,500 for individual coverage and $3,000 for family coverage. The out-of-pocket limits cannot exceed $7,500 for an individual or $15,000 for family coverage.

Frequently Asked Questions (FAQs)