The Health Savings Account: A Triple Tax Break for Retirement

You can put money into a health savings account only while a high-deductible health plan covers you, that plan is your only health coverage apart from narrow exceptions such as dental and vision, and nobody else can claim you as a dependent on their return. Enroll in Medicare and the contributions stop.

Each piece of that rule gets checked every month. A month on a regular plan loses that month’s room. So does a month covered by a spouse’s general-purpose health FSA.

The deductible has an IRS minimum. The contribution has an IRS cap. Both move every year, and the IRS publishes the new figures each spring for the year that follows, while Publication 969 sets out the HSA rules in full, including what counts as a qualified medical expense.

A break at every stage

Most tax-favored accounts give you one break going in or one coming out. An HSA gives you both, plus the years in between.

1. Contributions are deductible. Through payroll, they also skip Social Security and Medicare taxes.
2. Growth is untaxed. Interest, dividends and gains inside the account are never reported while they stay there.
3. Withdrawals for qualified medical expenses are untaxed, at any age.

A traditional IRA has the first two. A Roth has the second and third. Only the HSA has all of them, which is why people who can afford to leave it alone treat it as a retirement account that happens to pay medical bills, and spend from it only when they have to.

Withdrawals that are not medical

Spend HSA money on anything else and the rules depend on your age.

Before 65, you pay income tax plus a 20% additional tax. That’s steep. On a hypothetical $2,000, the additional tax alone is $400.

From 65, the 20% goes away. A nonmedical withdrawal is then taxed as ordinary income and nothing more, exactly like a traditional IRA withdrawal, so an HSA you never needed for health care turns into an ordinary retirement account at 65 while its medical withdrawals stay tax-free for life.

The HSA also has no required minimum distributions. You can leave it growing as long as you like. Who inherits it matters, though. A spouse named as beneficiary takes it over as their own HSA. Anyone else gets the balance as taxable income in the year of your death, which is one reason to spend an HSA before a Roth late in life, since heirs usually get a Roth without income tax.

Paying now, reimbursing later

Pay medical bills from your pocket today. Keep the receipts. Leave the HSA invested. Years later, reimburse yourself.

The IRS sets no deadline for the reimbursement. The one condition is timing. The expense has to come after the HSA was opened, and a bill from the year before you had the account never qualifies, however carefully you kept the paperwork for it.

This only pays off if you can cover medical costs from cash flow. If the bills would go on a credit card, spend from the HSA directly. The tax break still applies.

Where it fits with the Roth

The HSA and the Roth accounts from the first lesson do overlapping jobs. Health costs in retirement are large and hard to predict, and they include premiums and long-term care as well as doctor visits, all of which the long-term care course covers in detail. Money earmarked for them in an HSA never gets taxed. Size the rest with the retirement savings estimate.

The last lesson moves money the other way: taking pre-tax savings, paying the tax now through a Roth conversion, and the backdoor route for high earners.