How to Use Your HSA as a Retirement Plan

Whether you’re just starting out in your professional life or nearing retirement, one of the biggest burdens that can dampen your golden years is healthcare spending.

In fact, a recent study by Fidelity Investments found that by the age of 65, the average couple would need to save $315,000 to cover healthcare costs. And that after taxes.

But one tool that can help you save for health care expenses in retirement is a Health Savings Account (HSA).

What is an HSA?

An HSA is a tax-advantaged savings vehicle coupled with a high-deductible health care plan (HDHP) to help people pay for qualifying health care expenses. It is best known for its triple tax advantages.

1. The money you contribute to an HSA is tax deductible. So it can lower your taxable income and tax bill for the year you contribute.
2. Money in an HSA grows tax-free.
3. Qualifying healthcare expenses are tax-free.

In many ways, an HSA works similar to a traditional Individual Retirement Account (IRA) or 401(k). But HSAs have great advantages. When you withdraw money from a traditional IRA or 401(k) to pay medical bills, the withdrawal is taxed as ordinary income.

But if you tap into your HSA instead, you won’t owe any federal taxes on the payout as long as the spend is “qualified.” What exactly are qualifying medical expenses?

HSA-qualified medical expenses may include:

• co-payments.
• co-insurance.
• Health insurance deductibles.
• Dental and eye care.
• Prescription drugs and insulin.
• Medicare Part B and Part D premiums for prescription drugs.
• wheelchairs and walkers.
• hearing aids.
• X-rays.
• emergency services.
• Long-term care for the chronically ill.
• Nursing home expenses.
• home care services.

But there is more to it than that. Unlike Flexible Savings Accounts (FSA), HSA money rolls over into the next year. And unlike IRAs, you’re not required to take Minimum Distributions (RMDs) when you turn 72. So your money can keep growing until you need it.

Plus, you keep your HSA if you change jobs.

Invest your HSA money

To get the most out of your HSA, you need to let it grow as much as possible. However, many employers offer HSAs, which work like simple savings accounts and earn little interest. Today, the average savings account rate is just 0.13%.

Still, many employers offer access to a range of investment opportunities. And if not, you can always open an HSA online through an investment management company.

A self-directed HSA can give you access to a variety of investment options, including fee-free exchange-traded funds (ETFs) and index funds.

These funds generally aim to mimic the returns of market indexes such as this S&P500, which includes shares of some of the largest companies in the country. The average return for the S&P 500 over the long term has been 10%.

Either way, you should invest your HSA dollars in a diversified portfolio based on your goals and risk tolerance. Several online tools can help you find an appropriate asset allocation or asset mix.

Think of your HSA as a retirement account

While an HSA is designed to help people pay qualified healthcare expenses at all times, it can be really useful when you retire.

As you age, your health needs can become more complicated, and so can the price. So try to cover ongoing healthcare costs out of your own pocket and don’t touch your HSA until you retire. This gives you time to build up a sizable nest egg to cover qualifying healthcare expenses tax-free.

And once you turn 65, you can withdraw money from an HSA penalty for anything. That money could complement other retirement needs.

But remember, money withdrawn from an HSA for any reason other than qualifying medical expenses is taxable, even if exempt from punishment, and even after age 65.

If you withdraw money from an HSA for an ineligible expense and you are under the age of 65, your withdrawal will be subject to a penalty of 20% in addition to regular income tax.

Maximize your HSA

If you have an HSA, consider maxing it out if you can. For 2022, you can contribute up to $3,650 for individual insurance and $7,300 for family insurance. For 2023, you can contribute up to $3,850 for individual insurance and $7,750 for family insurance.

If you are at least 50 years old, you can make an additional catch-up contribution of $1,000.

So let’s put that into perspective. Let’s say you’re 40 years old, have individual coverage, and you maximize your HSA every year until you turn 65. Assuming a 10% annual return, your account would grow to $398,513.

But not everyone can maximize their HSAs every year. So let’s take the same scenario but instead invest $1,200 per year ($100 per month). You would end up with $131,018. Combined with other savings like tax-advantaged retirement accounts and Social Security benefits, this can help ensure a healthy and comfortable retirement.