The Basics of an HSA 

HSAs are personal health savings accounts that can be used to pay for qualified medical expenses tax-free. Contributions into your HSA and investment earnings also grow tax-free. HSAs act similarly to a 401(k) in that, after the age of 65, HSA funds can be used as retirement accounts and can be used for non-qualifying medical expenses penalty-free.

There is one point of clarification about spending HSA funds at retirement—after reaching age 65, any money spent from the HSA on non-qualified medical expenses must be reported as income and will require income taxes to be paid on that amount. But again, if the funds are used for medical expenses, they are not considered taxable income.

HSA Funds Are Always Yours 

Of course, another compelling, key feature of HSA funds tied to your high-deductible health plan is that, unlike basic insurance premiums, HSA contributions are always yours and never expire, even in the event of a job change. 

When considering an HSA as a retirement vehicle, it’s important to evaluate when to spend your HSA funds. Whatever you don’t spend you keep, so you may want to minimize spending HSA funds for medical expenses unless absolutely necessary.

Of course, qualified medical expenses, including your deductible, is certainly what those funds are for, but from a retirement savings perspective there are few investment vehicles like an HSA that allow three tax advantages:

1. On the initial contribution, 
2. On the investment / growth, and
3. When you spend it on qualified expenses. 

So, to that end, the HSAs growth component is in many respects more powerful than even the simple medical savings feature—just something to consider before spending from your HSA account.

Understanding Your  Tax-Savings 

When you use a payroll deduction to fund your HSA you make contributions on a pre-tax basis—meaning every dollar you contribute from your paycheck is a tax-free dollar added to your HSA. 

For simplicity, let’s assume you have a 25% tax rate and that by the end of the year you have personally contributed $4,000 to your HSA account, investing in part the savings from your high deductible health plan’s lower premiums. Because that $4,000 contribution is tax-free, you gain an additional $1,000 in buying power for medical expenses that you wouldn’t have had without the tax-free HSA contribution.

Without the HSA contribution, you’d essentially be paying that $1,000 in taxes. Ask yourself—would you rather pay $1,000 in taxes or earn money in your HSA? When you contribute to your HSA you report lower taxable income and, therefore, pay less taxes. This means that you can keep those tax savings and tuck them away for retirement also.

Tax-Free Growth and Investment Earnings

Much like a 401(k) or an IRA, once you’ve saved $2,000 in your HSA, you should consider investing your funds to save for retirement. If you start early, HSA funds can accrue tax-free investment earnings that may grow substantially over time.

Based on the earlier assumptions—25% tax bracket and $4,000 annual HSA contribution—over a 20-year period you could grow an HSA balance over $51,000 for medical expenses. With a total contribution of $80,000 (4k per year x 20 years) you could also save roughly $20,000 in taxes over the same time period. Combined, the benefits of pre-tax contributions, tax-free earnings, and tax-free withdrawals for qualified medical expenses add up to significant savings over the course of 20 years. 

 Catch-Up Contributions

Each year, the IRS sets HSA contribution limits. For 2020, the contribution limits are $3,550 for individual coverage and $7,100 for family coverage. Once you’re 55, you can contribute an extra $1,000 to your HSA over the normal contribution limits each year, or a “catch-up contribution.” If you’ve invested your HSA funds, this means you can save substantially more to use in retirement.