HSAs – An Underrated But Powerful Retirement Asset

Health Savings Accounts (HSAs) are often pigeonholed as merely a tool for managing healthcare expenses.

However, their utility extends far beyond this, making them a versatile and potent asset for retirement planning. This blog post explores the multifaceted role of HSAs, highlighting their benefits as a retirement asset, the flexibility they offer post-65, and the unique investment opportunities they provide, including self-directed investing.

HSAs: More Than Just Healthcare Funds

Primarily, HSAs are known for their role in covering healthcare costs with pre-tax dollars.

Contributions reduce your taxable income, growth is tax-free, and withdrawals for qualified medical expenses are also tax-free. This triple tax advantage makes HSAs the most tax-efficient way to pay for healthcare expenses.

However, the beneficial effects of having a healthy balance in a health savings account extend far beyond healthcare. HSAs can also be an excellent overall retirement asset due to their flexibility and tax benefits. 

The 20% HSA Penalty Goes Away at 65

One of the most significant advantages of HSAs is their flexibility after the age of 65.

Before this age, non-medical withdrawals from HSAs come with a hefty 20% penalty on top of income taxes. However, once you turn 65, this penalty disappears. You can then withdraw funds for any purpose, paying only the income tax due on the withdrawal, similar to a traditional IRA.

This flexibility allows HSA funds to be used for a variety of retirement expenses, not just medical costs. Whether it’s helping with living expenses, travel, or even non-medical emergencies, HSAs can provide financial support.

But HSAs are superior retirement assets to traditional IRAs in one important respect: unlike other tax-deferred retirement accounts like traditional IRAs, SEPs, SIMPLE IRAs, 401(k)s, and 403(b)s, HSAs do not have Required Minimum Distributions (RMDs) starting at age 72.

This gives account holders more control over their funds well into retirement. HSA owners who don’t need the money to live on can allow the fund to increase tax-deferred as long as they like.

Self-Directed Investing within HSAs

A lesser-known feature of HSAs is the ability to self-direct investments.

Like self-directed IRAs, self-directed HSAs allow investors to diversify their portfolios beyond traditional stocks and bonds.

That means you can potentially use your HSA to invest in real estate, precious metals, mutual funds, bonds and bond funds, and more, in the hope of generating better returns over time.

This option not only potentially increases the growth of HSA funds but also provides you with additional control over your investment choices.

However, investing involves risk. You should also carefully consider the effect that losing 20, 30, 40, or 50% would have on your overall financial security in retirement. This is especially critical if you’ve left the workforce, since you have a limited capacity to earn new income to compensate for your losses.

HSAs as a Bridge to Social Security

One of the critical strategies in retirement planning is the delayed claiming of Social Security benefits.

By postponing the initiation of Social Security benefits until age 70, you can significantly boost your monthly Social Security payout when you do choose to take benefits.

However, this delay creates a gap in income for those who retire before age 70.

If you have a good-sized HSA, you can use your balance to supplement your living expenses penalty-free. And you can still use it to pay qualified medical expenses completely tax-free.

This may make it much easier to delay taking Social Security benefits.

You can combine your HSA with a Roth IRA, a cash value life insurance policy, or an annuity to help build your bridge to Social Security.

HSAs and The Deathbed Drawdown Strategy

An often overlooked strategy is the “deathbed drawdown.”

While HSAs are the best vehicle for paying healthcare-related expenses, they are not the best assets to pass on to heirs from an estate planning perspective.

This is because inherited HSAs generate an immediate income tax liability to whoever inherits them.

This is a very disadvantageous treatment compared to IRAs, which allow heirs to spread the tax liability over as many as ten years, or to other assets that may qualify for a stepped-up basis on the death of the original owner.

It may be a good idea to try to spend down your HSA ahead of other assets toward the end of your life. Especially on medical care, since your HSA distributions to pay these qualified medical expenses qualify for tax-free treatment.

Your heirs can also use your HSA to pay tax-free for your medical expenses for as long as 12 months after your death – further reducing their eventual income tax penalties, and preserving assets with more favorable tax treatment.

How to Open an HSA

Anyone can open a health savings account. But to contribute to it, you must be covered under a qualified high deductible health plan (HDHP).

Alternatively, you can purchase the special limited value HSA MEC policy and combine it with a health sharing plan. If you don’t have access to other first-dollar coverage through another plan, and you own HSA MEC, you can save thousands of dollars in income taxes by contributing the maximum to your HSA.

Key Takeaways

HSAs are a highly flexible and tax-efficient tool that can significantly enhance retirement planning.

Their benefits extend well beyond healthcare, providing financial support for a range of retirement expenses, investment opportunities, and strategic tax planning.

By understanding and utilizing the full spectrum of benefits offered by HSAs, retirees can secure a more stable and prosperous financial future. Whether for immediate medical costs or broader retirement needs, HSAs stand out as a uniquely powerful asset in any retirement portfolio.

Get Help

Want to get started making tax-free contributions to your own HSA? Our expert, experienced Personal Benefits Managers are ready to assist you – no charge!

You can get personalized assistance selecting an HDHP or a health sharing plan that you can combine with HSA MEC for an incredible combination of monthly savings compared to traditional unsubsidized health insurance premiums, as well as the ability to use your accumulated HSA funds to buy healthcare or even pay long term care insurance premiums with tax-free dollars.

For Further Reading: How to Get the Most Out of Your HSA Account | HSA Contribution Limits in 2024 | HSA Eligibility Criteria