4 Ways to Maximize Your HSA Retirement Strategy

Reviewed by Molly Moorhead, CFP®
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You’ve probably heard of health savings accounts, or HSAs. 

You can use these accounts to pay medical expenses if you have a specific type of health plan with high out-of-pocket costs. 

But with sweet tax advantages, HSAs can also be a smart way to save for future medical expenses in retirement. Think of it like a 401(k) for health care costs. 

We’ll dive into four specific ways you can use an HSA to achieve your retirement planning goals. But first, here’s a quick rundown of how HSAs work, including tax benefits and other key advantages. 

What is a Health Savings Account?

A health savings account (HSA) is a tax-advantaged account you can use to pay for medical expenses. 

You — not your employer or insurance company — own and control the funds in your HSA.

There were about 30 million active HSAs as of June 2021 — about five times more than in 2011, according to Devenir, an HSA provider. The company estimates that almost 1 in 5 Americans in their 30s has a health savings account. 

Most people use their HSA to pay for medical expenses not covered by a high-deductible health plan (HDHP), such as copays at the doctor’s office and other qualified medical expenses. 

But with attractive tax benefits and flexibility, health savings accounts can also be an ideal long-term investment vehicle for retirement. 

​​Instead of withdrawing money from your HSA each time a medical expense arises, experts recommend paying for medical costs out of pocket and letting the money in your HSA continue to grow. 

Who Can Open an HSA?

You must be enrolled in a high-deductible health plan with no additional health coverage to contribute money to an HSA. 

However, not all high-deductible health plans are HSA-eligible, so check with your insurer or HR department to ensure your plan qualifies. 

HSA Contribution Limits

Like a 401(k) or IRA, health savings accounts have annual contribution limits. 

The maximum yearly HSA contribution in 2022 is $3,650 for an individual medical plan and $7,300 for someone with a family plan. 

Contribution limits also include employer contributions.

There’s an additional $1,000 catch-up contribution for people ages 55 and over.

Each year, you decide how much to contribute to your HSA account, up to these limits. If you have an HSA through an employer, you can set up automatic contributions from your paycheck.

Unused funds in an HSA roll over year after year, unlike a flexible spending account (FSA), so there’s no fear of “use it or lose it.” 

You can’t continue to make HSA contributions if you’re no longer covered under a qualifying high-deductible health plan. However, an HSA is portable, meaning you can take it with you when you switch jobs or retire. 

Even if you no longer qualify to make contributions, you can always spend funds inside your HSA — or leave them alone to keep earning interest and growing. 

HSA Penalties 

You can use money in your HSA at any time to pay for qualified medical expenses penalty- and tax-free. 

When you turn 65, you can use your HSA for anything without facing a penalty (although you’ll still owe income tax on non-qualified medical withdrawals, just like you would with any traditional retirement account). 

There’s a 20% penalty if you withdraw money from an HSA for non-qualified medical expenses before age 65. You’ll also pay income tax on these non-qualified withdrawals. 

What Are the Tax Benefits of an HSA?

A health savings account offers several attractive tax benefits. 

HSAs are said to have a triple tax advantage:

  1. You can contribute pre-tax dollars at work (Your contributions also escape FICA taxes).
  2. You won’t pay any tax on earnings inside the account. (Any interest, dividends, or capital gains you earn are tax-free).
  3. You can withdraw the money tax-free at any time to pay for qualified medical expenses.

Many people contribute to an HSA via payroll deductions. But if you use your own money to fund an account, you’ll qualify for a tax deduction on your yearly return — even if you don’t itemize. 

Not sure what counts as a qualified medical expense? Use this publication from the Internal Revenue Service to see what qualifies. 

You Can Invest Your HSA Funds Like a 401(k)

You can invest money inside an HSA so it grows tax-free over time. 

Many HSAs let you invest your money in stocks, bonds, mutual funds and ETFs. 

However, few people take advantage of this unique investment strategy to maximize their retirement tax savings.  

Only 9% of account holders invested a portion of their HSA balance in 2020, according to an Employee Benefit Research Institute study published in October 2021. The rest — 91% — held their full balance in cash.

Some HSA providers offer more — and better — investment options than others. 

For example, some HSAs carry high annual administrative and transaction fees, while others require you to reach a minimum balance of $1,000 or more before you can fund your HSA investment account. 

Your workplace HSA may not be great. If that’s the case, try shopping around to find a better HSA provider elsewhere. HealthSavings Administrator, ​​Lively, Fidelity, HSA Bank and Optum Bank are a few mainstream HSA providers with good investment options. 

Whichever provider you choose, look for one with high-quality, low-cost investments that align with your age and risk tolerance.  

Investing with an HSA is a great way to grow your money for retirement health care expenses — if you don’t need the funds anytime soon. 

If you think you might need to tap your HSA for upcoming health care expenses, set aside some of your account in cash before investing the rest. 

How to Use Your Health Savings Account for Retirement Planning

An HSA can be an excellent retirement planning tool. 

As we age, medical expenses increase quickly. By maximizing your contributions, investing them, and leaving the balance untouched until you exit the workforce, you can create a nice health care nest egg for yourself. 

Plus, you’ll benefit from significant tax savings along the way. Here are four ways your HSA can be used: 

1. Health Savings Accounts Can Serve as a Bridge to Medicare for Early Retirees

Is early retirement in your future? You might want to consider an HSA. 

If you retire before age 65, you’ll be on the hook for all your future medical costs until Medicare kicks in at age 65. 

You may be able to obtain health coverage from a former employer for a short time, or join your spouse’s health insurance plan. 

But for other early retirees, the only option is buying your own health insurance from an independent agent or signing up for a plan on the Affordable Care Act Marketplace. 

Your premiums will be higher because you’re over age 45. If you opt for an ACA plan, you’ll pay more for a health plan if your household’s modified adjusted gross income (MAGI) is high. 

To bridge the gap between early retirement and Medicare, consider opening an HSA while you’re young.

Using an HSA as a bridge can be especially helpful for members of the Financial Independence Retire Early (FIRE) movement. These individuals often earn high salaries, which they frugally save and invest in order to quit the workforce as soon as possible, often by age 45 or 50.  

A health savings account gives you a reliable source of retirement income to cover medical costs until you qualify for Medicare. You can use HSA money to cover your deductible and copays. 

Or you can forgo health insurance for as long as possible, and utilize your HSA to cover any out-of-pocket qualified medical expenses. 


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2. HSAs Can Cover What Medicare Doesn’t

Once you join Medicare, you will no longer be eligible to contribute to an HSA — but you can still use money inside your account to cover health expenses. 

Your HSA can pay for Medicare premiums, deductibles, copays and coinsurance. 

This can really help you save money down the road. In 2022, Medicare Part B premiums are $170.10 a month and most people pay a 20% coinsurance payment for covered services, plus a $233 annual deductible. 

An HSA can also pay for other Medicare expenses, including dental expenses, eyeglasses, hearing aids and over-the-counter medicine. (However, HSA funds can’t be used to pay for Medigap supplemental insurance premiums.)

Finally, HSA distributions aren’t included in your modified adjusted gross income, so they won’t impact your Social Security benefits.

Have questions about Medicare? Here are 7 things you should know.

3: Use Your HSA to Reimburse Past Medical Expenses 

HSAs don’t restrict when a health care expense is incurred and when it’s reimbursed. In other words, a distribution doesn’t have to pay for current medical expenses to be tax free. 

Save receipts from qualified medical costs that you paid from non-HSA sources, then take reimbursements from your HSA when you need extra cash to supplement your retirement savings. 

This way you can use your HSA balance to reimburse yourself for those earlier medical costs.

Just make sure to keep receipts and proof of payment in case the Internal Revenue Service audits you or your HSA provider raises questions. 

And remember, you can’t use your HSA balance to reimburse yourself for medical bills you paid prior to establishing the account.

Learn how to use your HSA to pay off old medical bills.

4. HSAs Can Pay for Long-Term Care

According to data from insurance company Genworth Financial, the average annual cost of an in-home health aide in 2020 was $​​54,912, while a private room in a nursing home cost more than $105,850 a year. 

Paying for long-term care is a major financial challenge for many families. A well-funded HSA can help.

That’s because an HSA can cover things like in-home nursing care, retirement community fees, long-term care services and nursing home fees.

Money in an HSA can also pay for long-term care insurance premiums, up to a certain amount per year based on your age. 

Funding an HSA when you’re young and healthy can provide a financial safety net in case you need long-term care services in the future. This is especially helpful since Medicare doesn’t cover extended nursing home stays or adult day care. 

HSAs can also be a smart way to pass down money to your spouse after you die. 

If you name your spouse as the beneficiary of your account, the account becomes his or her HSA after you die. 

That means your spouse can allow the account to continue growing and withdraw funds tax-free for his or her own qualified medical expenses. Plus the transfer of ownership is completed free of probate. 

You can also name a nonprofit organization as the beneficiary of your HSA, and the account will be paid to the charity tax free outside of probate. 

HSA vs. 401(k) 

HSAs and 401(k)s can both help you save for retirement. And they both offer tax advantages. 

A 401(k) provides tax-deferred growth, meaning the money inside grows tax-free until you make a withdrawal. At that point, you’ll pay tax on the withdrawal. If you’re younger than 59.5 years old, you’ll also face a 10% penalty. 

Unlike traditional retirement accounts, money in an HSA is accessible penalty-free at any age if used on qualifying medical expenses. 

However, you’ll face a 20% penalty for non-medical withdrawals from an HSA before age 65. After 65, you can access your HSA for non-medical expenses and pay only income tax on the withdrawals, just like you would with your traditional IRA or 401(k).

Unlike a 401(k), an HSA does not require the account holder to begin withdrawing funds at a certain age. You can leave your HSA untouched as long as you like and continue to let it gain value over time without paying taxes. In contrast, you must start taking required minimum distributions from a traditional IRA or 401(k) at age 72. 

Annual contribution limits are another big difference between HSAs and retirement accounts. In 2022, you can contribute up to $20,500 a year to a 401(k). 

In contrast, HSA limits are capped at $3,650 for an individual medical plan or $7,300 for someone with a family plan per year. Both 401(k)s and HSAs allow an additional catch-up contribution for people 55 and older. 

Is an HSA Retirement Strategy Right for You?

Using an HSA to save for retirement isn’t right for everyone. 

Since an HSA is only available to people with high-deductible health plans, you need to make sure this type of health insurance works for you.  

Many people are hesitant to enroll in HDHPs because they worry about affording future or current medical costs. 

In 2022, the minimum deductible for an HDHP is at least $1,400 for self-only coverage and $2,800 for family coverage. 

Annual out-of-pocket expenses can run as high as $7,050 for individual coverage — or $14,100 for family coverage. 

That’s why these accounts may not be a good fit for people with high health care costs, like pregnant women or people with chronic illnesses. 

Using an HSA as a retirement savings vehicle may be a more viable option for affluent individuals and families who can use the tax benefits and afford the risk. 

Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.