Health Savings Accounts as a Retirement Planning Vehicle

Health Savings Accounts, or HSAs, were created in 2003 through the Medicare Prescription Drug, Improvement, and Modernization Act. Early adoption was slow, but growth in recent years has been impressive as more and more Americans become familiar with their many benefits.

For years, HSAs have been used as a means to set aside money for health care expenses and receive an income-tax deduction on the contributions. A downside of HSAs is that they must be associated with a high deductible health plan (HDHP) so they may not be the optimal approach for those struggling with health issues or limited cash flow; the elevated out of pocket costs may negate any income tax benefit.

In addition to the immediate income tax benefit, an HSA can also be a fantastic tool for retirement planning as withdrawals for qualified medical expenses and even Medicare premiums can be taken income-tax free. If started early and funded well, an HSA can accumulate a significant balance to assist with future health care costs.

To qualify as an HDHP in 2018, the deductible must be a minimum of $1,350 for an individual and $2,700 for a family, or a maximum of $6,650 for an individual and $13,300 for a family.

Here are the key features of HSAs:

  • Funded through payroll deduction, contributions made directly from the individual and/or their employer.
  • Can be funded with a one-time rollover from a Traditional IRA up to the annual contribution limit, currently $3,450 for an individual plan and $6,850 for a family plan.
  • Balances carry over from year-to-year.
  • Withdrawals before age 65 for non-qualified purposes are subject to ordinary income tax plus a 20% penalty.
  • Accounts must have a beneficiary designation. A spouse is the ideal beneficiary as the HSA can continue on as normal when inherited by a spouse. Otherwise, HSA treatment is lost and the full value of the account is includible as income to the beneficiary[i].
  • Accounts are considered “Triple-Tax Free”:
  • Contributions are income-tax deductible;
  • Growth on HSA funds is tax-deferred (While HSA funds can be invested, I recommend leaving in cash an amount equal to 4-5 years of your health care deductible) ;
  • Distributions are tax-free if for qualified medical expenses. (What are qualified medical expenses?)

From a retirement planning standpoint, the combination of benefits is unique:

  • Withdrawals after age 65 for non-qualified expenses avoid the 20% penalty, though they are still treated as ordinary income. Essentially, after age 65 an HSA functions like a Traditional IRA, except…
  • There are no required minimum distributions after age 70 ½!
  • Because withdrawals for qualified medical expenses are income-tax free, this may help you avoid an income-related adjustment in Medicare premiums[ii]. (How are Medicare Part B premiums determined?)
  • Medicare premiums can be paid from an existing HSA, though an individual on any part of Medicare cannot make an HSA contribution.
  • You can make a $1,000 annual catch-up contribution after age 55.
    • If both spouses are covered by an HDHP and over 55, each must have an HSA account to take advantage of the catch-up provision[iii].
  • A little known feature of an HSA is that funds can be used to reimburse a medical expense from a prior year, provided the HSA was active and it was a qualified medical expense not claimed as an itemized deduction for tax purposes[iv].

As you can see, there are great benefits to an HSA when used properly. Does that mean you should immediately ditch your current health insurance plan? Of course not, but with wise planning an HSA can provide benefits now and in the future.

Please reach out to us if you’d like help evaluating the merits of an HSA.







Ryan Smith
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Born and raised on the North Shore of Massachusetts, I moved to Raleigh in 2011 to marry my wife, Emily. We have two kids, Jack and Gwen, a golden retriever named Olly, and are members of Church of the Apostles. I have been a Financial Advisor since 2005 and earned a Master’s of Science in Financial Planning from Bentley University in 2007. I became a CFP® professional in 2009, a Retirement Income Certified Professional® in 2015, and a Certified Tax Specialist™ in 2023.