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Health Savings Accounts (HSAs) may be one of the best account types in the Internal Revenue Code. Unlike Flexible Spending Accounts (FSAs), the balance you accumulate in your HSA is yours to keep indefinitely until you withdraw it. HSAs enjoy three types of tax savings:

  • a tax deduction for contributions
  • tax-free growth of funds inside the HSA
  • tax-free withdrawals when used to pay for qualified medical expenses

The IRS publishes contribution limits for HSAs annually. For 2021, the contribution limits are $3,600 for individual coverage and $7,200 for family coverage. Taxpayers age 55 and older can make an additional $1,000 catch-up contribution. Employers and employees can both contribute to HSAs, provided the combined total does not exceed the IRS contribution limit.

In order to contribute to an HSA, an individual must be enrolled in a high deductible health plan (HDHP). HDHP options have become more popular offerings in employer-sponsored health insurance plans in recent years. Individuals who do not obtain health insurance through an employer can also contribute to HSAs if they are enrolled in an HDHP. For tax year 2021, the IRS defines an HDHP as a health insurance plan with a minimum annual deductible of $1,400 for individual coverage or $2,800 for family coverage and a maximum out-of-pocket expense of $7,000 for individual coverage or $14,000 for family coverage.

Although there are significant benefits to HSAs, enrolling in an HDHP may not be the right fit for you or your family. If you anticipate incurring significant medical expenses in the upcoming year, a lower deductible plan may be a better fit. It is important to run the numbers annually to determine the right type of health insurance plan for your situation.

HSAs and Retirement Savings

Many HSA owners know about the tax benefits of contributions and distributions but miss out on the potential to invest HSA funds that can create even greater long-term tax savings. When used properly, an HSA can arguably be an even more powerful tool in a retirement portfolio than a Roth IRA. Most HSA custodians will deposit contributions into a savings account by default. By doing some research and asking questions, you may discover that your HSA custodian allows you to invest your account balance in mutual funds. If your HSA custodian does not allow for funds to be invested, you can transfer your HSA to a different custodian that offers investment options.

The ideal way to use an HSA as a retirement savings account is to maximize contributions annually, invest the funds for long-term growth, and avoid taking distributions to pay for current medical expenses. If your cash flow allows for it, pay for medical expenses from your bank account to allow the HSA to grow as much as possible over the years. If you pay for medical expenses out of your bank account, keep detailed records of those expenses for years in which you were covered by an HDHP because you can retroactively reimburse yourself from your HSA should you need to access HSA funds in the future.

A 2020 study published by Fidelity estimates that the average 65-year-old couple will need $295,000 (after-tax) to pay for health care costs during retirement, not including long-term care. By contributing to an HSA annually and investing it for growth, individuals can increase their chances of having enough money set aside for health care costs during retirement.

A Few Important Details about an HSA

A few additional notes are in order. HSA funds can be withdrawn at any time for non-medical expenses, but the IRS will assess ordinary income tax plus a 20% penalty on such distributions. At age 65, the 20% penalty goes away but the ordinary income tax remains for distributions that are not used for medical expenses. Once you enroll in Medicare, you can no longer contribute to an HSA. If your Medicare enrollment occurs mid-year, you can make a pro-rated HSA contribution for that year covering the months prior to your Medicare enrollment.

The rules surrounding HSAs are complex. Therefore, it is advisable to consult a tax or financial advisor on your situation.


This is intended for informational purposes only and should not be construed as personalized financial advice. Please consult your financial professional regarding your unique circumstances.

Author Nicholas J. DeJong Financial Advisor

Nick has been involved in the financial services industry since 2013. He earned a bachelor of science degree in accountancy and a master of accounting science degree from Northern Illinois University.

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