Health Savings Accounts (HSAs) offer a unique triple tax exemption along with the possibility for long-term compounding, making them an exciting financial planning tool. Since HSA funds can be distributed at any time for qualified medical expenses, you have the option to pay out-of-pocket for current medical expenses (if your health and financial situation allows), invest the funds held within the HSA, and let the account grow tax-deferred over time. Later, you can reimburse yourself for previously incurred medical expenses (provided you maintain proper records), effectively treating the account as a retirement savings vehicle rather than using it for current medical expenses.
For example, let’s assume John and Jane Doe have a High Deductible Health Plan (HDHP) and an HSA account. They choose to pay for medical expenses out-of-pocket while maximizing their HSA contributions each year. For simplicity, let’s assume the maximum HSA contribution remains $8,550 per family annually (though this amount will likely increase with inflation over time). If they invest the full family contribution amount each year and the account grows at 6% annually, after 20 years, the HSA would be valued at $314,516.80, even though they contributed only $171,000. John and Jane Doe would then have a substantial medical expense nest egg to help cover past or future healthcare costs. Since healthcare can be one of the largest “unexpected” expenses in retirement, using an HSA to prepare for qualified medical expenses can be a valuable retirement planning strategy.
As mentioned, there is no time limit for reimbursing yourself from an HSA, if the expenses occurred after you became eligible for and opened the account. Additionally, after age 65, the HSA can be used like a traditional IRA for non-medical expenses without the 20% penalty, although non-medical distributions will be taxed at your ordinary income tax rate. However, withdrawals for qualified medical expenses remain tax-free. This flexibility allows you to accumulate medical expenses over time, keep thorough records, and reimburse yourself in retirement, with tax-free distributions. Another great feature is that HSAs, unlike Traditional IRAs, do not have required minimum distributions (RMDs), allowing the funds to grow tax-deferred indefinitely.
Now that we have discussed growing an HSA over time, what happens if the account holder passes away? If your spouse is the designated beneficiary, the HSA avoids probate, and your spouse can take it over as their own. However, if the HSA is left to a non-spouse beneficiary, the account must be fully withdrawn by the end of the year of the account holder’s death and is fully taxable to the beneficiary. Non-spouse beneficiaries can reduce the taxable amount by any qualified medical expenses incurred by the decedent before death, provided the beneficiary pays them within one year after the date of death. Note that funeral expenses are not considered qualified medical expenses. If the estate is the beneficiary, the HSA must be fully withdrawn and taxed on the decedent’s final tax return, with no option to reduce the taxable amount by qualified medical expenses. Therefore, it is essential to plan for how you and your spouse will utilize the HSA funds to avoid a potentially large tax bill. As with any account, periodically review and update the named beneficiary as needed.
Important Considerations
The IRS has the authority to audit your HSA, so it’s essential to keep proper documentation for any qualified medical expenses reimbursed from your HSA. This includes receipts, mileage logs for medical-related travel, tax records (e.g., Form 8889), HSA account statements, itemized medical bills, and other related tax forms (Schedule A, Form 1040). The records should demonstrate that distributions were used exclusively for qualified medical expenses, were not reimbursed from another source, and were not claimed as an itemized deduction.
While Health Savings Accounts (HSAs) can be a valuable planning tool, it’s important to ensure that a High Deductible Health Plan (HDHP) fits your healthcare needs and financial situation. Maintaining an emergency fund is essential to cover potential deductibles and out-of-pocket expenses, which may be higher with an HDHP. Additionally, after opening an HSA, many people forget to invest the funds. If you plan to invest, make sure to allocate the funds according to your goals and risk tolerance. Finally, always keep proper documentation to substantiate medical expenses for future reimbursement from the HSA.
It is prudent to review your situation with your insurance and tax professionals.
For more information about HSA account basics, please see our HSA Basics handout available here.
Rather listen in? Check out Amplified Wealth’s “According to Plan” podcast on HSA accounts – or watch the full episode below!
