How to Use Your HSA in Retirement

How to Use Your HSA in Retirement
Elliott Appel, CFP®, CLU®, RLP®

Elliott Appel, CFP®, CLU®, RLP®

Welcome! I'm Elliott, the founder of Kindness Financial Planning, LLC, a fee-only, fiduciary advisor located in Madison, WI working virtually with widows and caregivers across the United States. When I'm not helping people live their ideal life, I'm often cooking for my wife, playing tennis, or hiking.

Health savings accounts (HSAs) are not only a powerful planning tool to pay for qualified medical expenses, you can also use your HSA in retirement.

HSAs are triple tax-advantaged. You get a tax deduction for contributions, pay no taxes on earnings, and can withdraw money tax-free for qualified medical expenses. 

Whether you are early in your career, approaching retirement, or in retirement, an HSA can be a part of your tax-efficient withdrawal strategy. 

What is an HSA?

An HSA account is a type of account you can make contributions to if you have an HSA-eligible health plan. 

Benefits of an HSA

There are three main benefits to an HSA:

  • Contributions are tax-deductible
  • Earnings grow tax-free
  • Withdrawals can be made tax-free for qualified medical expenses

This means if you are in the 32% federal marginal tax bracket and contribute $7,750 (2023 family maximum HSA contribution), you may reduce your taxes by about $2,480. 

Then, if you have earnings of 5% in a year and it grows to $8,137.50, the growth of $387.50 is tax-free. 

If you decided to spend a portion or all of the account on qualified medical expenses, you could do it tax-free. You could withdraw the full $8,137.50 and pay no tax. 

An HSA combines the best features of a pre-tax 401(k) and a Roth 401(k). You get a tax-deduction for contributions and withdrawals are tax-free for qualified medical expenses.

You can also use an HSA to pay for non-medical expenses, but distributions would be taxable as ordinary income and may have a penalty if they occur before the age of 65, which will be discussed more later in the article.

An HSA is one of the most powerful types of accounts. 

Qualify for an HSA

The HSA-eligible health plan deductibles and maximum out-of-pocket expenses can change each year. 

For example, in 2023, you need a deductible of at least $1,500 for individual coverage and $3,000 for family coverage. Out-of-pocket costs also can’t exceed $7,500 for an individual and $15,000 for a family. 

You also can’t be enrolled in Medicare or claimed as a dependent on someone else’s tax return. 

If you select a plan that meets these requirements, then you may be able to contribute to an HSA. 

Annual Limits of an HSA

For 2023, the maximum contribution you can make is $3,850 for individual coverage and $7,750 for family coverage. For those who are age 55 or older, you can also contribute an extra $1,000.

For 2024, the maximum contribution you can make is $4,150 for individual coverage and $8,300 for family coverage. For those who are age 55 or older, you can also contribute an extra $1,000.

You have until the tax filing deadline to contribute to an HSA. For example, for 2023, you can make contributions up until April 15, 2024. 

Special Note: If you aren’t enrolled in the HSA-eligible health plan for the full year, you may only be able to make a pro rata contribution; however, if you are covered on December 1 through December 31 of the following year, you may be able to contribute the maximum amount allowed. 

The pro rata calculation is calculated by adding the number of months you were enrolled in an HSA-eligible health plan on the first of a month and dividing by 12. 

For example, if you had individual coverage through August 31, 2024, you would calculate it as follows:

(8/12) * $4,150 = $2,766. 

An example of how you could make the full year worth of contributions is if you joined a plan on November 28, 2024, then you may be able to make a full year of contributions if you maintain coverage through December 31, 2025. 

You don’t want to contribute when you are not eligible. You may be subject to a 6% excise tax in the year you contributed and in every year following if you do not remove the excess contributions and its earnings. 

Retirement Planning: How to Use Your HSA in Retirement

Instead of using your HSA while working, one strategy is to allow it to compound tax-free for years or decades and then use it. 

Otherwise, you may be making one of the 27 retirement planning mistakes.

While making an HSA contribution and then immediately using it is often still better than forgoing an HSA because you get the tax-deduction with the contribution, the most powerful feature of an HSA is that contributions and earnings can grow tax-free. 

Estimated Cost of Healthcare Expenses in Retirement 

One common concern is worrying about building up too large of a balance to use it while in retirement. 

Depending on which report or study you look at, a retiree aged 65 today may need about $157,500 after tax to pay for health care expenses in retirement. For a couple, it may be over $315,000! 

Given that many healthcare costs have been rising faster than general inflation, I’m not worried about finding healthcare expenses in retirement. 

It’s often one of the biggest line items in retirees’ budgets. 

Qualified Medical Expenses

Since HSAs can only be used tax-free for qualified medical expenses, it’s important to understand what would count as a qualified medical expense. 

IRS Publication 502: Medical and Dental Expenses lists some of those expenses. 

Below are a few examples:

  • Dental treatments
  • Drug prescriptions
  • Insulin
  • Physical therapy
  • Surgery
  • Doctor’s visits and co-pays
  • Eyeglasses
  • Acupuncture
  • Ambulance

As you can see, many expenses related to medical care may count as a qualified medical expense.

As people age, their spending often shifts. For example, while travel, food, and hobby expenses are typically higher in early retirement, they often go down as people age. As people get older, their spending on healthcare often goes up, paving the way for using an HSA later in retirement. 

If an HSA is not used for qualified medical expenses, there is a 20% penalty plus ordinary income taxes on the amount withdrawn; however, at age 65 you can take penalty-free distributions for any spending. You pay ordinary income tax, but there is no 20% penalty. 

Investing Your HSA for Retirement

If you’ve decided you want to use your HSA later in retirement, the next question becomes, “How do I take advantage of the tax-free compounding for a decade or more?”

You could invest it! 

Example of Investing HSA for Retirement 

I meet many people who have their HSA in a cash account earning a minimum amount. Let’s compare it to someone who proactively plans for their retirement and decides to invest their HSA. 

For this example, let’s say each person starts with $20,000 in their HSA through years of contributions. The person who keeps it in cash earns 0.5% per year and the person who invests earns 6% per year. 

Look at the difference over 30 years. 

Invest HSA vs. Keep in Cash Comparison

The person who invests has over $108,000 after 30 years while the person who keeps it in cash has less than $23,200. 

The person who took a proactive approach now has over $108,000 that can be used for qualified medical expenses going forward or they can reimburse themselves for past expenses, which I’ll talk about more in a later section. 

Evaluating Financial Institutions – Consider a Rollover

One of the common issues people face is that their HSA may not have any investment options, they are required to keep a certain amount in cash, or they have limited investment options. 

This is easily solvable. 

An HSA can be moved to another HSA custodian with more investment options. For example, Schwab in coordination with Lively has an HSA option or Fidelity also has an HSA

They typically allow you to invest the whole account without needing to keep a certain amount in cash. Plus, since these are self-directed accounts, you can usually invest in any type of investment you’d be able to through an IRA, Roth IRA, or brokerage account. It’s typically not limited to a few different investments. 

You could open an HSA with another custodian and request that your current custodian move the funds to your new HSA. 

If you are still employed, you could keep contributing through the custodian your employer uses and roll over the funds once a year or every few years, depending on the rollover fees your custodian charges. It’s normally better to make contributions directly through payroll because those contributions avoid payroll taxes whereas contributions outside of payroll (i.e. made directly to your HSA by you) do not. 

Contributions made outside of payroll still receive a tax deduction, but you would pay Medicare and Social Security taxes on it. 

Using another HSA custodian may reduce costs and allow you access to other investment options. 

Using your HSA in Retirement 

Once you are in retirement, a common question is, “When should I use my HSA in retirement?” 

While some people advocate for using it in early retirement, I prefer to wait and allow it time to grow tax free. 

In addition to the qualified medical expenses listed above, you can use your HSA for Medicare premiums, Part B and part D deductibles, copays, and coinsurance (not Medigap policies though). You can even pay for long-term care insurance premiums up to a certain amount. 

One strategy people use is paying with a rewards credit card for qualified medical expenses and then reimbursing themselves instead of using the debit card that comes with the HSA.

It allows them to rack up rewards on their credit card while still using the HSA. 

Saving Medical Receipts – Best Practices

As I mentioned earlier, you can use your HSA for prior expenses as long as the expenses were incurred after you established your HSA. 

For example, if your HSA was established 20 years ago, you could reimburse yourself for an expense you had 19 years ago. 

The simplest way to do it is to track your expenses closely, which I generally suggest people do the following:

  • Scan or take a picture of your receipt showing the medical expense and listing the file as “YEAR, Month, Day – Description of Expense and Amount” and putting it in an electronic folder that is backed up to the cloud. For example, it could be “2024 0115 Eyeglasses 300.”
  • Make a spreadsheet of the expenses by year with a total and back it up to the cloud. For example, you could have columns for the following:
    • Date
    • Amount
    • Description
    • Reimbursed (Yes/No)
    • Total by Year

This allows you to quickly know the running total of how much you could reimburse yourself for any time and the receipt that is easily findable if you ever needed to justify the expense. 

Here is a sample Excel template to track your HSA expenses.

Sample spreadsheet for tracking to use HSA in retirement

Using your HSA After Age 65

Another benefit of an HSA is that at 65 or older, you can use it like a Traditional IRA. 

You can take withdrawals without the 20% penalty, pay ordinary income taxes, and use the funds for non-medical expenses. For example, you could take a withdrawal and use it to pay for travel expenses. 

Instead of the withdrawal being tax-free, you would owe ordinary income taxes on it. 

It’s still better to use the HSA for qualified medical expenses because you can get tax-free withdrawals, even reimbursing yourself for prior medical expenses. But, if you exhausted that amount, you could still use it at 65 for other expenses. 

This is another reason why HSAs are powerful retirement tools and why I’m okay allowing it to compound for a long time. You have the flexibility to reimburse yourself for prior qualified medical expenses and can still use it like a pre-tax account in retirement for non-medical expenses. 

Dying with an HSA

One downside to an HSA is that non-spouses inheriting an HSA could face steep tax consequences.

Spouses can inherit an HSA and treat it as their own, meaning they can continue taking tax-free withdrawals for qualified medical expenses or pay ordinary income taxes at age 65 for non-medical expenses. 

If you name anyone other than your spouse, such as a child, sibling, or other person, they will face ordinary income tax on the whole amount at death. They must withdraw the full amount from the HSA and pay tax on it. 

For example, if you named a sibling as the beneficiary and died with an HSA worth $50,000, your sibling would need to withdraw the $50,000 and would pay ordinary income tax on the full $50,000. 

The exception is that the beneficiary could use the HSA for up to one year after death to pay for qualified medical expenses that happened for the original account holder prior to death. 

If you have a spouse who can inherit an HSA, spending from it immediately is less of a concern. 

If you are the surviving spouse with a large HSA, you may want to consider taking withdrawals since the taxation for non-spouse beneficiaries is not favorable. 

Final Thoughts – My Question for You

HSAs are tax-favored retirement savings vehicles.

Many people choose to make HSA contributions and spend them, but if you have the patience and time to use them properly, they can make a meaningful difference throughout retirement. 

Whether you use them for tax-free qualified medical expenses in the current year, reimburse yourself for prior year medical expenses, or take withdrawals and pay ordinary income taxes at age 65, you have flexibility and options to use them tax-efficiently in retirement. 

I’ll leave you with one question to act on. 

How are you going to use your HSA? 

Disclaimer: This article is for general information and educational purposes only and should not be considered investment, financial, legal, or tax advice. It is not a recommendation for purchase or sale of any security or investment advisory services. Please consult your own legal, financial, and other professionals to determine what may be appropriate for you. Opinions expressed are as of the date of publication, and such opinions are subject to change. Click for full disclaimer.

Share This Post

Share on facebook
Share on linkedin
Share on twitter
Share on email

Educational and Thoughtful
Content to Your Inbox

More To Explore

How Much Umbrella Insurance Do I Need

How Much Umbrella Insurance Do I Need?

Last Updated on May 3, 2022 Umbrella insurance is one of the least talked about insurances, which is highly problematic. Umbrella insurance is an important