Hidden Gem: HSAs

Hidden Gem: HSA in Retirement

The health savings account or “HSA” is a little-understood vehicle for tax-deferred savings for medical expenses. This tax-preferred account can prove useful not only during your working years but also in retirement. Many people think it is just to defer current-year taxes for medical out-of-pocket costs, but it can be used much more strategically, even in retirement.

What is an HSA

An HSA is a tax-advantaged account that is paired with a high-deductible health plan (HDHP). You can’t establish an HSA unless you are enrolled in an HDHP. An HDHP provides “catastrophic” health coverage that pays benefits only after you’ve satisfied a high annual deductible. The HSA was designed to help pay for health expenses not covered by the HDHP.

You can open one yourself, or your employer can open one for you. Contributions to an HSA are tax deductible if you contribute directly, or excluded from income if your company pays them. HSAs typically offer several savings and investment options. Your employer will let you know the funds or investment options that are available if you get your HSA through work. All investments are subject to market fluctuation, risk, and loss of principal, of course, so it is different than a savings account. You should not invest the money in your HSA if you plan to use the money in the current year or near term; keep it in cash.

Withdrawals from an HSA for qualified medical expenses are free of federal income tax. However, money you take out of your HSA for non-qualified expenses is subject to ordinary income taxes plus a 20% penalty, unless you have an exception.

Benefits of an HSA

An HSA can be a powerful savings tool. First, it is the only type of account that allows for both federal income tax-deductible or pre-tax contributions and tax-free withdrawals. (But some states do tax HSA contributions and earnings.) Another benefit is accumulation, because there is no “use it or lose it” provision, funds roll over from year to year. And the account is always yours, so you can keep it even if you change employers or lose your job.

HSA as a retirement tool

During your working years, if your health expenses are relatively low, you may be able to build up a significant balance in your HSA over time. You can let your money grow until retirement, when your health expenses are likely to be greater.

In retirement, medical costs may become one of your biggest expenses. Although you can’t contribute to an HSA once you enroll in Medicare (because it is not an HDHP), an HSA can help you pay for qualified medical expenses, allowing you to preserve your retirement accounts for other expenses (e.g., housing, food, entertainment, etc.).

An HSA may provide other benefits as well:

  • An HSA can be used to pay for unreimbursed medical costs on a tax-free basis, including Medicare premiums (although not Medigap premiums) and long-term care insurance premiums, up to certain limits.
  • You can repay yourself from your HSA for qualified medical expenses you incurred in prior years, as long as the expense 1) was incurred after you established your HSA, 2) you weren’t reimbursed from another source, and 3) you didn’t claim the medical expense as an itemized deduction.
  • Once you reach age 65, withdrawals for non-qualified expenses won’t be subject to the 20% penalty. However, the withdrawal will be taxed as ordinary income, similar to a distribution from a 401(k) or traditional IRA.
  • At death, if the surviving spouse is the designated beneficiary of the HSA, it will be treated as their own HSA.

HSAs aren’t for everyone. If you have relatively high health expenses, especially within the first year or two of opening your account, you could deplete your HSA or even face a shortfall. In any case, review the features of your health insurance policy carefully. The cost and availability of an individual health insurance policy can depend on factors such as age, health, and the type and amount of insurance.

Blue Spark Capital Advisors

We're a fee-only Registered Investment Advisory and financial planning firm based in New York City and the Berkshires.

We specialize in working with women after divorce, death of a spouse, or other life transitions such as retirement or job change. We provide financial planning and investment management services.

We believe in a holistic approach. Movement in each piece of your financial plan impacts the others, so we consider your entire picture.


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