A Health Savings Account — commonly called an HSA — is a tax-advantaged savings account that allows individuals enrolled in a high-deductible health plan to set aside money on a pre-tax basis to pay for qualified medical expenses. HSAs offer a unique combination of tax benefits that make them one of the most powerful savings tools available for healthcare costs — including long term care expenses in retirement.
Understanding how HSAs work, who can contribute to one, and how they interact with Medicare is especially important for people approaching retirement age.
How a Health Savings Account works
Money contributed to an HSA goes in tax-free, grows tax-free, and can be withdrawn tax-free when used for qualified medical expenses. This triple tax advantage makes HSAs uniquely valuable compared to other savings accounts.
Key features of HSAs include:
- Tax-deductible contributions — contributions to an HSA are tax-deductible whether made by you or your employer reducing your taxable income for the year
- Tax-free growth — money in an HSA can be invested in mutual funds and other investments and grows tax-free
- Tax-free withdrawals — withdrawals used for qualified medical expenses are completely tax-free at any age
- Rollover — unlike flexible spending accounts HSA funds roll over from year to year and never expire. There is no use-it-or-lose-it rule.
- Portability — the account belongs to you not your employer. You keep it if you change jobs or retire.
Who can contribute to an HSA
To contribute to an HSA you must meet all of the following requirements:
- Be enrolled in a qualifying high-deductible health plan — HDHP
- Not be enrolled in Medicare
- Not be claimed as a dependent on someone else’s tax return
- Not have other health coverage that is not a qualifying HDHP with limited exceptions
The requirement that you not be enrolled in Medicare is critical for people approaching age 65. Once you enroll in any part of Medicare — including Part A — you can no longer contribute to an HSA. However you can continue to use existing HSA funds tax-free for qualified expenses after enrolling in Medicare.
HSA contribution limits
The IRS sets annual contribution limits for HSAs which are adjusted periodically for inflation. For 2024 the contribution limits are:
- $4,150 for self-only coverage
- $8,300 for family coverage
- An additional $1,000 catch-up contribution is allowed for people aged 55 and older
These limits apply to total contributions from all sources including employer contributions.
Qualified medical expenses
HSA funds can be used tax-free for a wide range of qualified medical expenses including:
- Doctor visits, specialist consultations, and urgent care
- Hospital and emergency room care
- Prescription medications
- Dental care including cleanings, fillings, and orthodontia
- Vision care including eye exams and eyeglasses
- Mental health services
- Physical therapy and occupational therapy
- Medical equipment such as wheelchairs, crutches, and hearing aids
- Long term care insurance premiums up to certain age-based limits
- Medicare premiums — including Part B, Part D, and Medicare Advantage premiums — after age 65
- Qualified long term care expenses
Using HSA funds for non-qualified expenses before age 65 results in both income tax and a 20 percent penalty. After age 65 withdrawals for non-qualified expenses are subject to ordinary income tax but no penalty — similar to a traditional IRA.
HSAs and Medicare — critical timing considerations
The interaction between HSAs and Medicare enrollment involves important timing considerations that catch many people off guard:
- Enrolling in Medicare stops HSA contributions — once you enroll in any part of Medicare you can no longer contribute to an HSA. This includes Part A which is premium-free for most people.
- Retroactive Medicare enrollment — when you apply for Social Security benefits after age 65 Medicare Part A is often made retroactive up to six months. If you were contributing to an HSA during those months you may have made excess contributions subject to a penalty.
- Part A enrollment at 65 — if you are not collecting Social Security at 65 you can delay Part A enrollment and continue contributing to your HSA. However you must enroll in Medicare when you eventually stop working and lose employer coverage.
Because of these complexities people who want to continue contributing to an HSA past age 65 should consult with a financial advisor or benefits counselor before enrolling in Medicare.
Using your HSA in retirement
An HSA can be a powerful retirement healthcare savings tool. Healthcare costs are one of the largest expenses retirees face and an HSA provides a dedicated tax-advantaged pool of funds specifically for those costs.
Strategies for using an HSA in retirement include:
- Pay current medical expenses from other funds and let the HSA grow — if you can afford to pay current medical expenses out of pocket during your working years your HSA can accumulate and grow significantly by retirement
- Save receipts — there is no time limit on reimbursing yourself from an HSA for qualified expenses. You can pay medical expenses out of pocket now save the receipts and reimburse yourself from your HSA years later tax-free.
- Use for Medicare premiums — after age 65 you can use HSA funds tax-free to pay Medicare Part B, Part D, and Medicare Advantage premiums — a significant benefit for retirees
- Use for long term care insurance premiums — HSA funds can be used tax-free to pay long term care insurance premiums up to age-based annual limits set by the IRS
How much should you save in an HSA
Financial experts often recommend maximizing HSA contributions every year you are eligible especially in the years before retirement. A couple who maximizes HSA contributions for 20 years with modest investment growth could accumulate well over $200,000 in tax-free healthcare savings.
Fidelity Investments regularly estimates that a 65-year-old couple retiring today will need approximately $300,000 or more for healthcare expenses in retirement not including long term care costs. An HSA can help bridge this significant gap.
Finding and opening an HSA
HSAs are offered by banks, credit unions, and specialized HSA administrators. Many employers offer HSAs alongside their high-deductible health plans. If your employer does not offer an HSA you can open one independently at many financial institutions.
When choosing an HSA provider consider:
- Investment options — some HSA providers offer a wide range of investment options while others only offer savings accounts
- Fees — some providers charge monthly maintenance fees that can erode your balance over time
- Minimum balances — some providers require a minimum balance before you can invest
Key terms to know
- Health Savings Account — HSA — a tax-advantaged account for people with high-deductible health plans to save for qualified medical expenses
- High-deductible health plan — HDHP — a health insurance plan with a higher deductible than traditional plans that qualifies the enrollee to contribute to an HSA
- Triple tax advantage — the combination of tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified expenses
- Qualified medical expenses — expenses eligible for tax-free HSA reimbursement as defined by the IRS
- Catch-up contribution — an additional HSA contribution allowed for people aged 55 and older
- Rollover — the ability to carry unused HSA funds from one year to the next without losing them
Sources
- Internal Revenue Service — irs.gov
- HealthCare.gov
- Medicare.gov
- USA.gov
This article is for general informational purposes only and does not constitute legal or financial advice. HSA rules and contribution limits are subject to change. Consult a licensed financial advisor or tax professional for guidance specific to your situation.