A Health Savings Account Can Save You Money in Retirement

Most people know that health savings accounts (HSAs) are tax-free money for medical expenses. But if you plan carefully, HSAs can also be a valuable source of retirement savings, providing a triple tax benefit that's even better than a 401(k).

HSA contributions are tax deductible when you make them. The earnings are tax deferred through the years. And when you withdraw money for qualified medical expenses, it's tax free.

That's three tax breaks. Your 401(k) only gives you two.

Medical care is a big part of retirement spending. Fidelity Investments estimates that a 65-year-old couple retiring in 2022 will need about $315,000 to cover health care expenses in retirement—including Medicare premiums, copayments, deductibles, and prescription drug costs.

If you start planning, the HSA can be a great source of tax-free money for those expenses and more.

How to Save More in an HSA

You can't make new contributions to a health savings account after you enroll in Medicare. But you can contribute before then if you have an HSA-eligible health insurance policy, whether through your employer or on your own.

In 2023, the policy must have a deductible of at least $1,500 for self-only coverage or $3,000 for family coverage. You can contribute up to $3,850 in 2023 if you have self-only insurance coverage or $7,750 for family coverage, plus an extra $1,000 if you're 55 or older.

Many employers contribute to employees' accounts—an average of $870 for Fidelity's employer plans.

You have until the tax-filing deadline to contribute to an HSA for the previous calendar year. That means you have until April 18, 2023, to make tax-deductible HSA contributions for 2022.

Tax-Free Withdrawals for Medicare Expenses

You're not taxed on HSA money you use to pay out-of-pocket medical expenses at any age. Deductibles, copayments, prescription drugs, over-the-counter medications. Also eligible expenses insurance doesn't cover—dental work, hearing aids, vision care.

You can withdraw money tax free to pay eligible long-term-care insurance premiums, with the amount based on your age. In 2023:

• $480 for age 40 or younger

• $890 for ages 41 to 50

• $1,790 for ages 51 to 60

• $4,770 for ages 61 to 70

• $5,960 if you're older than 70

The biggest benefit for retirees: After you turn 65, you can also withdraw money tax free from the HSA to pay Medicare premiums for you and your spouse for Part B, Part D, and Medicare Advantage plans.

You can't use HSA money for Medicare Supplement Insurance (Medigap), but you can use it for regular Medicare premiums.

These costs add up. The Fidelity study found that the average 65-year-old couple pays more than $120,000 in premiums for Part B and Part D during their lifetimes.

If you're automatically paying Medicare premiums from your Social Security benefits, you can withdraw money tax free from your HSA to reimburse yourself. Keep records of the premiums you paid.

After you turn 65, you can also withdraw money from the HSA for nonmedical expenses without incurring a 20 percent penalty, but you'll have to pay taxes on those withdrawals.

The Strategy to Build Tax-Free Money

Here's where it gets interesting. A quirk of HSA rules gives you unlimited time to withdraw money tax free for any eligible expenses you incurred since you opened the account.

If you use other cash for those expenses at the time, you can leave the money growing in the HSA for the future and then withdraw it tax free anytime.

So if you can afford to pay medical expenses out of pocket now, do it. Save the receipts. Let your HSA grow. Then decades later, reimburse yourself tax free for those old expenses.

Most HSAs let you invest in mutual funds for long-term growth, in addition to offering a savings account for short-term expenses.

Keep records of all HSA-eligible expenses you paid out of pocket through the years. You can look up eligible expenses in IRS Publication 502.

You can also make tax-free HSA withdrawals to pay health insurance premiums if you lose your job and are receiving unemployment benefits or if you continue your employer's coverage on COBRA.

Steven Hamilton, an enrolled agent authorized to represent taxpayers in front of the IRS, recommends holding on to receipts of eligible expenses and the explanation of benefits from your insurance company.

Some HSA administrators, like Fidelity, provide tools that make it easy to keep track of eligible expenses.

Why This Matters

If most of your savings is in tax-deferred accounts like traditional IRAs and 401(k)s, being able to withdraw money tax free from your HSA can help lessen your tax bill.

The money you withdraw from an HSA for qualified medical expenses isn't included in the income calculations that determine whether you're subject to the Medicare high-income surcharge or if you have to pay taxes on your Social Security benefits.

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