How to Use HSA for Retirement

Make the most of your HSA by incorporating it into your retirement strategy. Find out how to strategically use your HSA for a secure financial future.

When it comes to retirement planning, many people focus on having a traditional 401(k) or individual retirement account (IRA) in place. However, one often overlooked tool that can be incredibly beneficial for retirement planning is a health savings account (HSA). Even if you are years away from retiring, it’s never too early to start considering how you can maximize the benefits of an HSA for your retirement strategy.

Here's what you need to know about using your HSA for retirement.

What is an HSA and How Does It Work?

A health savings account is a tax-advantaged account you can set up if you have a qualified high-deductible health insurance plan (HDHP). Under an HDHP, a higher deductible is your trade-off for paying lower monthly insurance premiums.

With an HSA, you can offset higher out-of-pocket costs by setting aside money in an account to pay for qualified medical expenses. These costs may include deductibles, copays, prescriptions and dental care. Health insurance premiums are typically not eligible costs you can use HSA funds for.

You can realize significant tax benefits with an HSA. The contributions you make come from pretax dollars. So, your taxable income drops by the eligible contributions you have made. IRS set the contribution limits each year. In 2024, the HSA contribution limit is set at $4,150 for single coverage and $8,300 for family coverage.

How to Use Your HSA in Retirement

Here are the various ways you can leverage your HSA for optimal retirement planning.

Maximize Contributions Before Retirement

Before you retire, it is important to consider maximizing your contributions to your HSA to take advantage of the tax benefits. The more you contribute to your HSA, the more funds you will have available.

In addition, HSA contributions are not subject to required minimum distributions (RMDs) like traditional retirement accounts such as 401(k)s and IRAs. This means that you can continue to contribute to your HSA and let the funds grow tax-free for as long as you like, without being forced to withdraw a certain amount each year once you reach a certain age.

Invest Your HSA Funds Wisely

Many HSAs allow you to invest your HSA funds in a variety of investment options, such as mutual funds or stocks. This can potentially earn you a higher rate of return than leaving them in a traditional savings account.

When choosing investments for your HSA, it's important to research and choose options that align with your risk tolerance and financial goals. If you are risk-averse, you may want to choose more conservative investments, such as bond funds or money market funds. If you are comfortable with more risk, you may opt for more aggressive investments, such as growth stocks or equity funds.

Use HSA Funds for Qualified Medical Expenses

In retirement, you can use your HSA funds tax-free to pay for a wide range of qualified medical expenses, including premiums for Medicare Parts A, B, and D, as well as long-term care insurance premiums. According to the IRS, qualified medical expenses are expenses that are primarily for the prevention or treatment of a physical or mental illness. This can include a wide range of expenses such as doctor's visits, prescription medications, medical procedures and even certain alternative therapies.

Even if you don't use your HSA funds for medical expenses right away, be sure to save your receipts. You can reimburse yourself from your HSA at any time for qualified medical expenses you incurred after you opened the account. Expenses for cosmetic procedures or over-the-counter medications not prescribed by a doctor are generally not considered qualified.

Pros and Cons of Using an HSA for Retirement

An HSA can be a helpful financial tool when you retire. Below are some benefits and drawbacks of using an HSA as part of your retirement strategy. 

Benefits

The financial advantages of using an HSA as a retirement account can have a long-term impact.

• Growth: Like a traditional retirement account, the money you contribute to an HSA can be invested and grow over time. You can use these earnings tax-free for qualified medical expenses when you retire.
• Tax advantages: You get a tax break on your HSA contributions and earnings. You pay no tax on HSA withdrawals for qualified medical expenses, even when you retire. However, if you were to withdraw funds from a traditional retirement account to pay these expenses, you would pay income tax on these distributions. 
• Flexibility: Although HSA funds are set aside for qualified medical expenses, you can withdraw them for other purposes if you have to. If you are younger than 65, you get hit with both income tax and a 20% penalty on any nonqualified expenses paid. Once you reach age 65, you will still owe income tax, but you’ll avoid the 20% penalty.
• Roll-over funds: Money in your HSA can roll from year to year. So, you can keep these funds in your HSA retirement account until you need them.
• No minimum distributions: Unlike traditional 401(k)s and IRAs, you don't need to take minimum distributions from an HSA. You can keep money in your HSA as long as you want.
• Portable: An HSA is like a bank account you own. If you change jobs or health insurance policies, you don't lose what you have saved.

Drawbacks

Contributing to an HSA requires a significant commitment, so you’ll want to consider some of these drawbacks.

• Recordkeeping: You'll need to keep documentation of qualified medical expenses in the event of an audit. The IRS could disallow the HSA’s favorable tax treatment without proof.
• States taxes: You might owe state tax on HSA activity, depending on where you live. For example, California levies a state tax on interest or earnings in an HSA in the year they are earned.
• Limited investment choices: HSA plans vary based on the provider. Some plans let you invest in stocks, bonds or mutual funds, whereas others do not. If you can't invest your money, your savings account may experience limited growth.
• Medicare enrollment: You can no longer make contributions when covered by Medicare insurance. If your Medicare enrollment is retroactively applied, you cannot realize any tax benefits on the contributions made during this time. Plus, you might incur a 6% excise tax on these excess contributions. 

Use an HSA as Part of your Retirement Strategy

Incorporating your HSA as part of your retirement strategy can help you maximize savings now and when you retire. An HSA is flexible, portable and offers plenty of tax benefits. You get a tax break as you contribute and enjoy tax-free earnings as your money grows. Once you retire, you can avoid paying taxes by using HSA funds for qualified medical expenses.

Frequently Asked Questions