Saving for retirement is difficult, but it’s an important part of everyone’s financial life. There are a number of ways to make saving for retirement easier, such as using tax-advantaged accounts like individual retirement accounts (IRAs) and 401(k) plans.
One special type of tax-advantaged account, the health savings account (HSA), isn’t specifically designed to help people save for their retirement. However, its unique benefits make it one of the most powerful tax-advantaged accounts out there.
If you have access to an HSA, it can be one of the best ways to set money aside for retirement.
How Do HSAs Work?
Understanding how HSAs work is essential to making the most of them when it comes to saving for both health care and your retirement. You risk paying penalties if you fail to follow the rules.
First, not everyone can open an HSA. They’re only available to people who have a qualifying high-deductible health plan.
An insurance plan’s deductible is the amount that you pay before your insurance kicks and starts covering costs. For example, if you have a $2,000 deductible, you have to pay $2,000 toward your health care expenses before your insurance pays any of the cost. Typically, an HDHP has lower monthly premiums than other plans.
For an insurance policy to qualify as an HDHP, it must meet the following requirements:
- It charges a higher annual deductible than typical health plans (for 2022, the minimum is $1,400 for individuals and $2,800 for families).
- It has a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses that you must pay for covered expenses (for 2022, the maximum is $7,050 for individuals and $14,100 for families).
- It may, but is not required to, provide preventative care without a deductible or with a lower deductible.
The exact requirements for a health care plan qualifying for an HSA are:
- You are covered by an HDHP.
- You have no other health insurance coverage, with the following exceptions:
- Liabilities incurred under workers’ compensation laws, tort liabilities, or liabilities related to ownership or use of property.
- A specific disease or illness.
- A fixed amount per day (or other period) of hospitalization.
- Coverage for accidents, disability, dental care, vision care, and long-term care.
- You aren’t enrolled in Medicare.
- You aren’t claimed as a dependent on anyone else’s tax return.
If you meet the requirements, you can open an HSA.
Like other tax-advantaged accounts, you cannot make unlimited contributions to an HSA. There is a limit on how much you can contribute each year, which prevents people from receiving a massive tax deduction.
For 2022, the limit is $3,650 for individual plans and $7,300 for family plans.
Some employers that offer HDHPs make contributions to their employees’ HSAs as an employee benefit. Employer contributions count toward these limits, so make sure you don’t exceed the contribution limit with your contributions and your employer’s contributions combined.
The primary reason that people use HSA for savings is the tax advantages. Like traditional IRAs and 401(k)s, the money you contribute to an HSA is contributed before tax. That means you can deduct the amount you add to the account from your income when filing your taxes.
If you have a taxable income of $50,000 and put $5,000 in your HSA, you can report your taxable income as just $45,000. That will save you about $1,100 on your tax bill, meaning your $5,000 contribution only costs you $3,900 out of pocket.
With a traditional IRA or 401(k), you pay income tax on the money that you withdraw from the account. HSAs are different. If you use the money in the account for qualified health expenses, you pay no taxes on the withdrawals either. This makes them doubly tax-advantaged.
If you have extra money in your HSA after you turn 65, you can begin making withdrawals from the account for nonmedical expenses too. If you do, you pay income tax on the amount you withdraw, but no penalties, just like a retirement account.
Qualified Withdrawals and Penalties
Typically, you can only withdraw money from an HSA for qualified medical expenses. The IRS outlines all qualified expenses in its Publication 502, but it includes most things you’d expect, including:
- Ambulance fees
- Birth control
- Body scans like MRIs or X-rays
- Contact lenses
- Dental treatment
- Drug addiction care
- Eye exams
- Hearing aids
- Hospital services
- Physical exams
If you withdraw money from an HSA for a nonmedical expense and you are under age 65, you pay a 20% penalty on the amount withdrawn. You also have to pay income tax on your withdrawal, meaning you are doubly punished for using the money for nonmedical expenses when you’re under 65.
Once you reach age 65, however, you can use HSA funds for nonmedical expenses penalty-free, but will still have to pay income tax on the amount withdrawn.
Although you generally don’t have to prove that you’ve used your HSA money for qualified medical expenses when you file your taxes, you should always save your receipts so that you can show how much you spent compared to how much you withdraw. The receipts will come in handy if you wind up getting audited.
How to Use an HSA for Retirement Investing
HSAs are useful for saving for health care expenses, but they’re one of the most powerful retirement accounts available to Americans. If you want to use your HSA to save for retirement, these tips can help.
1. Contribute as Much as You Can
If you want to use your HSA for retirement savings, the first thing to do is contribute as much as you can to the account.
Typically, you want to contribute to your 401(k) until you max out the amount that your employer will match. Getting employer matching contributions is like getting a raise, so it’s worth getting as much in matching funds as possible.
After that, you can focus on putting money in your HSA until you max it out.
2. Invest Your Balance
The name “health savings account” might make you think that your HSA is a simple savings account. Savings accounts pay interest, but they’re not great for long-term wealth building because you usually wind up losing spending power to inflation.
Depending on your HSA provider, you likely have the option to invest your HSA in the stock market. That means that you can use the money in your HSA to build an investment portfolio like you do in your retirement and taxable brokerage accounts. Building a portfolio of low-cost index funds is a great way to help your HSA’s balance grow.
Just remember to keep some of the money in cash if you plan on using the HSA to cover health expenses as well.
3. Wait Until You’re 65
Once you’ve opened your HSA, made contributions, and invested your money, all you have to do is wait. Once you turn 65, you can withdraw money from the account as if it were a 401(k) or IRA. There’s no requirement that you use the money for health care expenses after that.
The only downside of this strategy is that IRAs and 401(k)s are slightly more flexible when it comes to withdrawals. You can start taking money from those accounts, penalty-free, when you turn 59 ½.
4. Save Your Receipts
Even if you don’t plan to use your HSA to cover health care expenses, you should make sure that you save every medical-related receipt that you get.
The reason to save every receipt is that there is no time limit for withdrawing money from your HSA after you incur a qualified medical expense.
Consider this example: you injure your leg while out for a run and have to go to the hospital for surgery. After you recover, you get the hospital bill and have to pay $5,000.
You can withdraw money from the HSA now to pay the bill, or you can pay the bill out of pocket, leaving your money in the HSA to grow, tax-free. You decide to pay the bill out of pocket.
Because there’s no time limit on the reimbursement, you can take $5,000 out of your HSA, tax-free and penalty-free, any time you want. You can make the withdrawal tomorrow, next year, 10 years from now, or when you retire.
This is better than simply waiting until you turn 65 because withdrawals for nonmedical expenses still incur income taxes. If you pay for medical expenses out of pocket but save your receipts, you can withdraw from your HSA without paying any tax at all, up to the total amount of your qualified medical expenses that you’ve incurred over the years.
This makes HSAs more powerful than standard retirement accounts because you pay no tax on contributions or qualified distributions.
The full list of qualifying medical expenses is long, and some might surprise you. Over time, you’ll likely build up plenty of qualified expenses, which will make it easy for you to make tax-free withdrawals when you need to.
Advantages of Using an HSA for Retirement Investing
HSAs are one of the most powerful tax-advantaged accounts when used properly, so there are a lot of perks to using one for retirement savings.
1. Tax Benefits Add Up
One of the primary reasons to use an HSA for retirement savings is the tax benefits. If you use the account properly and save your medical receipts you can ultimately pay no tax on any of the money you contribute or withdraw from the account.
Even if you don’t have enough medical expenses to withdraw the entire amount tax-free, you have the backup plan of paying taxes on penalty-free withdrawals after you turn 65, effectively making the account into a second IRA or 401(k). Over the long term, the amount that you save in taxes can be huge.
If you’re in the 22% tax bracket — single earners making $41,775to $89,075 and couples making $83,550 to $178,150 — and withdraw $10,000 per year from your HSA tax-free, you save $2,200 per year in taxes. That means needing to save about $55,000 less for retirement if you’re using the 4% rule to determine how much of your portfolio to withdraw for retirement income.
2. HSA Contributions Don’t Count Against Retirement Contribution Limits
Using an HSA for retirement savings also increases the amount of tax-advantaged saving “cap space” you have for other retirement vehicles. IRAs and 401(k)s limit your contributions (to $6,000 per year and $20,500 per year, plus an optional $6,500 and $1,000 catch-up contribution, respectively, for those over 50). HSA contributions don’t count against those caps.
If you’re maxing out your tax-advantaged retirement contributions and looking for other ways to reduce your tax bill, HSAs can be an attractive option.
Disadvantages of Using an HSA for Retirement Investing
Just because you can use an HSA to save for retirement doesn’t mean that doing so is a good idea. Here are the disadvantages to consider.
1. You Might Need the Money for Health Care Costs
One reason not to use your HSA for retirement savings is the possibility that you might wind up needing that money to pay for medical costs. Odds are good that you’ll wind up with a big medical bill at some point in your life.
If you have a high-deductible health plan, the out-of-pocket expense for medical care could be significant, and unless you have a strong emergency fund in savings, you might need to tap your HSA account to pay the bill.
If your HSA is one of your primary methods of saving for retirement, you might have to dip into your nest egg to cover a medical emergency, which is never ideal.
2. HSAs Aren’t Designed for Retirement Investing
Another drawback is that HSAs aren’t designed for retirement saving. The tax rules surrounding HSAs make them a great way to save for retirement, but that isn’t their intended purpose. HSA accounts aren’t necessarily optimized for long-term investing.
Some HSA providers might not offer the option to invest your balance at all, or might offer options that charge hefty fees for the privilege. Some HSAs limit your investment options to expensive mutual funds whose fees can eat away at your balance over the long term, meaning your savings will grow much more slowly in an HSA than a specifically designed retirement account.
By contrast, many true retirement plans have specially designed investment options, such as target-date funds, that make saving for retirement easy.
3. The Rules for HSAs Could Change
Finally, just because HSAs are great for retirement savings now doesn’t mean that they will be 20, 30, or 40 years from now. The government could change the rules for how retirees can use their HSA balance. For example, the IRS may add a time limit for withdrawing funds after you incur a medical expense.
Future changes may make it harder to use the money you have in the account or alter the tax implications, which could limit its usefulness as a retirement savings vehicle.
HSAs can be a good way to save for retirement, but you need to have a high-deductible health plan to be eligible for one. Furthermore, you must be able to cover out-of-pocket medical expenses by other means in order to make the most of these accounts as retirement savings vehicles.
For most people, 401(k)s and IRAs will be the main methods of saving for retirement. Don’t forget that you can also benefit from opening a taxable brokerage account if you want to invest for long-term goals beyond retirement.