Should You Have a Health Savings Account?

Many employers now offer Health Savings Accounts (HSAs) to employees, prompting a common question: “Is an HSA right for me?” Traditionally, the answer depends on your medical plan and annual healthcare expenses. However, the unique tax benefits of HSAs make them worth considering even beyond current medical needs—they may be an effective part of a long-term retirement strategy.

Why HSAs Are a Powerful Savings Tool

HSAs are the only tax-advantaged savings accounts that offer triple tax benefits:

• Tax-deductible contributions

• Tax-free growth

• Tax-free withdrawals for qualified medical expenses

This rare tax treatment turns HSAs into an unconventional yet compelling retirement savings vehicle. While many people save for future living and medical expenses through a traditional IRA or 401(k), combining these with an HSA can provide greater flexibility and efficiency—especially for healthcare costs in retirement.

Because of their tax advantages, HSAs are often worth funding before contributing to an IRA and, in some cases, even before contributing to a 401(k)—especially when employer matching isn’t available or when you’re already contributing to other retirement vehicles.

That said, HSAs are not without limits. Withdrawals for non-medical purposes are subject to income tax and a 20% penalty. However, that penalty disappears once you reach age 65, at which point non-medical withdrawals are taxed like a traditional IRA distribution. If you’re already funding other retirement accounts and have manageable healthcare costs, maxing out your HSA—even at the expense of other savings—can be a smart move, offering some of the most tax-efficient dollars in your portfolio.

How HSAs Work and Who Can Contribute

To contribute to an HSA, you must be enrolled in a high-deductible health plan (HDHP). In 2016, this means a deductible of $1,300–$6,550 for individuals or $2,600–$13,100 for families. If eligible, you can contribute:

• $3,350 as an individual

• $6,750 as a family

• Plus, an additional $1,000 catch-up contribution if you’re 55 or older

Contributions are pre-tax, and employer contributions are excluded from your taxable income. Unlike flexible spending accounts (FSAs), HSA balances roll over each year with no expiration, and funds can be invested for long-term growth. Investment gains are tax-free if used for qualified medical expenses.

Qualified expenses include most costs that would typically qualify for a medical deduction, such as:

• Doctor visits, prescriptions, dental and vision care

• COBRA premiums

• Medicare premiums

• Long-term care insurance premiums (within limits)

Withdrawals for non-medical expenses are subject to income tax and a 20% penalty unless you’re over age 65, at which point the penalty is waived.

Strategic Uses: Now or Later?

The most common use of an HSA is to cover current medical expenses, offering better tax treatment than itemized deductions (which only apply beyond 10% of your adjusted gross income). However, many investors choose to pay current medical expenses out of pocket and allow HSA funds to grow for use in retirement.

Why? Because medical costs in retirement can be significant. According to Fidelity’s annual Health Care Cost Estimate, a 65-year-old couple retiring today is expected to spend $245,000 on healthcare alone. Saving HSA funds now and tapping them tax-free later for those inevitable costs can be a smart long-term strategy.

This approach does require strong cash flow and a high tolerance for paying out-of-pocket expenses in the present—so it’s not ideal for families with frequent or high medical bills. That said, the HSA allows for reimbursement at any time, meaning you can pay a medical bill in January and reimburse yourself in November, as long as the expense occurred while the account was active.

Final Thoughts

Health Savings Accounts offer a unique and powerful combination of tax benefits and long-term flexibility. While they shouldn’t be your only retirement vehicle, they can significantly enhance your overall strategy—especially when used thoughtfully alongside traditional retirement accounts.

Before adjusting your savings approach, we recommend consulting with a financial planner and a tax professional. Factors like 401(k) matching, your income, healthcare needs, and tax situation all play a role in determining whether maximizing your HSA makes sense.

Have questions about HSAs or your retirement strategy? We’re here to help—reach out anytime.

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