If you look around the internet enough for resources on how to build a retirement plan, you’ll probably come across Health Savings Accounts (HSAs). HSAs are discussed a lot in the Financial Independence/Early Retirement (FIRE) community as a cornerstone of an early retirement.

If you’re not familiar with HSAs, this might be confusing. You might be thinking, “Why did no one tell me about HSAs? Am I missing out by not having one as part of my retirement plan?”

The good news is that, while HSAs can be invaluable tools, and a useful part of a retirement plan if you already qualify for one, you’re not missing out if you don’t have one. There are plenty of alternative ways to save for retirement that everyone qualifies for, and that you can start contributing to right away.

In this article, we’re going to be going over some of the big picture details about how HSAs work, how they fit into retirement plans, and what your next steps are.

What is a Health Savings Account (HSA)?

Simply put, a Health Savings Account (HSA) is a savings account that you can only use for qualified healthcare expenses. HSAs are only available for people with a High-Deductible Health Plan (HDHP). They also come with tax benefits – contributions are tax deductible, earnings grow tax-free, and withdrawals are tax-free as well, if you use the money on qualified healthcare expenses. In 2022, individuals can contribute up to $3,650 and families can contribute up to $7,300, and folks over the age of 55 can make catch-up contributions of up to $1,000.

If you get your HDHP through your employer, they can also sponsor your HSA and make contributions to it. Their contributions count against your limit.

Who can open an HSA?

Health Saving Accounts are only available for individuals enrolled in a High-Deductible Health Plan (HDHP). As the name suggests, HDHPs have higher deductibles than most healthcare plans, though they usually have lower monthly premiums. For 2022, a HDHP is defined as having a deductible of at least $1,400 for an individual or $2,800 for a family. The total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) cannot exceed $7,050 for individuals or $14,100 for a family.

HSA eligibility is determined on an annual basis, but don’t fret: you’re able to keep an HSA and use it for qualified healthcare expenses even if you can no longer contribute to it. You are not eligible to contribute to an HSA once you are on Medicare, even if you also have an HDHP.

Benefits of an HSA

Health Savings Accounts come with many benefits. First, the tax benefits. You can contribute either pre-tax money via a payroll deduction or post-tax money, which you can claim on your tax return. The money in your account will grow tax free – interest, dividends, and capital gains in the account are nontaxable. Distributions are also tax free, granted that you use them on qualified healthcare expenses. Luckily, the list of qualified healthcare expenses is wide-ranging, and covers everything from acupuncture to home care to psychoanalysis.

Your balance carries over from year to year, even if you are no longer eligible to contribute funds. Plus, unlike retirement accounts, you don’t need to begin withdrawing funds at a certain age – they are equally available before or after you retire.

If you do want to use the funds in your HSA, it’s usually very convenient – most HSAs will issue you a debit card, giving you direct access to the funds.

Why use an HSA for retirement?

Because healthcare costs only get higher as we get older, an HSA can seem like a very attractive account to have as part of your retirement plan – there’s a reason that some FIRE proponents call them “retirement accounts for your medical bills.” Like IRAs or 401(k)s, you can purchase investments inside of your HSA, and your HSA balance has the potential to grow much faster than a regular savings account.

Additionally, you have a lot of freedom as to when you want to use the money inside of the account, and because withdrawals are tax-free, you don’t need to worry about withdrawing more than you need in order to account for your tax bill.

However, HSAs are not a silver bullet for covering healthcare costs in retirement.

Don’t move to an HDHP just for the HSA

The biggest downside to HSAs is that you are only eligible to contribute to an HSA if you have a HDHP. If you’re already on an HDHP, this might not be a major concern. But if you’re thinking of signing up for an HDHP in order to become eligible for an HSA, that might not be the right move.

While High-Deductible Health Plans have lower monthly premiums, they’re overall much more expensive if you have any kind of medical needs. You’ll need to pay much more out-of-pocket in order to hit your deductible, which is when your health insurance company starts chipping in. Even then, you may have more out-of-pocket copays and coinsurance costs that could cost you thousands of dollars in the event of an emergency or even regular care.

If you are young, don’t have a family, and typically healthy, a HDHP and HSA combo might serve you very well. But if you’re older, have kids, and have any existing health conditions, moving to a HDHP just to get an HSA is incredibly risky.

Alternatives to HSAs in your retirement plan

If you don’t qualify for an HSA, there are plenty of other ways to make sure you have enough saved for healthcare costs in retirement.

Make sure that you’re using your available tax-qualified retirement accounts, like an employer-sponsored 401(k). Employer-sponsored plans typically have a matching program, which can make a big difference to your overall savings balance.

You should also build a cash emergency fund to cover unexpected healthcare expenses. While cash in a savings account doesn’t have the same tax benefits as an HSA, it’s not subject to any additional tax penalties for withdrawals like traditional retirement accounts.

A Roth IRA can also be a great tool for retirement savings. You fund a Roth IRA with post-tax money, and in exchange, the balance grows tax-free and withdrawals are tax-free. Because withdrawals are tax-free, a Roth IRA can be ideal for covering large medical expenses, as you won’t have to take out extra cash in order to cover the tax bill.

Bottom line

HSAs can be a useful part of your overall retirement plan. However, if you don’t already qualify for one, it’s probably not worth the risk of signing up for a High-Deductible Health Plan just to get one, especially since there are multiple alternatives that are just as useful for retirement savings.

If you do have an HSA, make sure you are contributing up to your max every year in order to take full advantage of its tax benefits. Additionally, don’t forget that you can’t contribute once you turn 65, so make sure you contribute what you want before that point.

Have more questions about HSAs and how they fit into your retirement plan? Join Retirable and talk to a Certified Financial Planner® today.

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