We often hear from folks that are looking to maximize their savings opportunities prior to retirement.  Perhaps you are already taking full advantage of employer retirement plan contributions, contributing all you can to IRAs and Roth IRAs (if eligible) but still have dollars you would like to stash away for the future.  A commonly overlooked and misunderstood savings vehicle is the Health Savings Account or HSA.  Continue reading as we answer some Frequently Asked Questions and debunk some HSA myths.   

What is a Health Savings Account (HSA)?

An HSA is a type of account that allows eligible individuals to set aside pre-tax dollars to help pay for qualified medical expenses.  Not only do you receive the upfront benefit of a reduction in your taxable income for dollars that are placed into the account, but you can withdraw dollars tax-free at any time to pay for eligible medical expenses.  A little-known fact is that contributions made by salary deferral are exempt from Social Security and Medicare taxes.  Oftentimes these accounts are linked to a special debit card to be used to pay expenses directly.  If you withdraw funds prior to age 65 for non-medical expenses a 20% penalty applies and the withdrawal is added to your taxable income for the year.  You can find a list of qualifying medical expenses by visiting irs.gov.[1]

Who is eligible and how much can you contribute?

Individuals must have health insurance that is defined as a High Deductible Health Plan (HDHP) in order to contribute.  For 2021 and 2022, these plans must meet the minimum deductible of $1400 for individual coverage or $2800 for family coverage.  It is important to note that if you are currently enrolled in Medicare or are being claimed as a dependent on someone else’s tax return, you are NOT eligible to make contributions.  Those still working after age 65 should consider the pros and cons of Medicare enrollment versus continuing to make HSA contributions.

If you meet the requirements for a HSA, the total contributions by you and your employer cannot exceed $3600 for individual coverage or $7200 for family coverage for the 2021 tax year.  These amounts will be going up by $50 and $100 respectively for the 2022 tax year.  Those over the age of 55 can contribute an additional $1000 as a “catch-up” contribution.  If you haven’t fully funded your HSA for 2021, you may want to consider “topping-up” before the tax filing deadline to provide some additional tax savings for yourself. 

Myth #1 – If you don’t use it, you lose it.

This is false.  While they share some similarities with Flexible Spending Accounts (FSA) which carry these stipulations and inability to rollover balances from year to year, HSA account balances can continue to accumulate until the death of the HSA owner.   Even if you change employers, or health coverage to a plan that is not HSA eligible you can still keep the account active for future access. 

A surviving spouse will retain the tax benefits of HSA balances if named as beneficiary.  For all other beneficiaries, HSA balances will become taxable income to them in the year the owner passes away.

Myth #2 – HSAs can only be used for medical expenses.

After the age of 65 funds can be withdrawn penalty-free for any purpose (income taxes still apply for non-medical expenses) making them a potentially attractive way to supplement your retirement savings if your healthcare expenses are minimal or you can avoid tapping into them for routine healthcare expenses.  HSAs are NOT subject to Required Minimum Distributions like Traditional IRAs and other qualified account types. 

Myth #3 – HSAs earn very little interest so I’m better off saving in other types of accounts.

While it is entirely possible other types of accounts are more appropriate for your needs, think of choosing a Health Savings Account in the same way you would selecting a type of car.  If you determine a sedan is the best car for your needs you can choose to put just about any engine in it you want (i.e., a high performance V8, or the 4 cylinder that comes as standard equipment).  While the standard or default option for most HSAs is some type of cash account which currently earn minimal interest, you generally have the ability to invest balances as long as you leave a minimum amount in the cash option.  It has been our experience that most HSA owners have not given much thought to this or taken the time to investigate the investment options available to them in order to potentially earn more and grow their savings (investment and other fees may apply).  We are happy to do the investigating for you or provide more pointers if desired.        

Myth #4 – Tax-free HSA withdrawals to reimburse qualified medical expenses must be taken in the same tax year the expense occurred. 

This is false.  There is no time limit from the point the qualified expense is incurred and taking withdrawals from the account to reimburse the expense.[2]  The only requirement is that the eligible expense must have occurred after you opened the account.  Those using HSAs should keep records and/or receipts of any medical expenses in the event they need to prove these were indeed qualified expenses.  Under this treatment, it is possible that one keeping good records could take tax-free withdrawals from their HSA of the cumulative amount of all their qualified medical expenses incurred over many decades to offset their future non-retirement needs or for estate planning purposes! (No DeLorean required)

Making decisions that involve your family’s healthcare is both a personal and financial one.  While we have found incorporating HSAs into a financial plan to be valuable in many circumstances to increase savings and minimize taxes, your unique situation deserves the time and attention to see what is right for you.  We encourage you to contact your financial advisor and/or tax professional to see if these strategies may be beneficial for you.     

[1] www.irs.gov – Qualified Medical Expenses

[2] https://dpath.com HSA withdrawal penalties

Nick Hughes, CFP®
Nick Hughes, CFP®
Nick Hughes, CFP® is a Wealth Advisor with Visionary Horizons, LLC, a Registered Investment Advisory Firm in Chattanooga, TN.  Nick has been helping retirees and widows simplify their financial lives and develop more clarity about their future since 2007.  He has contributed to articles for Market Watch and FinancialPlanning.com and is a regular contributor to the Visionary Horizons blog.