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A Health Savings Account Now Can Save You Money in Retirement

HSAs can help cover out-of-pocket Medicare costs and provide a triple tax break

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Most people know that health savings accounts (HSAs) are a source of tax-free money to pay out-of-pocket medical expenses. But if you plan carefully, HSAs can also be a valuable source of retirement savings, providing a triple tax benefit that’s even better than a 401(k).

HSA contributions are tax deductible — even pretax if made through an employer plan — when you make them. The earnings from your HSA are tax deferred through the years. And when you withdraw the money for qualified medical expenses, you can do it tax free.

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Medical care is a big part of retirement spending. Fidelity Investments estimates that a 65-year-old couple retiring in 2022 will need about $315,000 to cover health care expenses in retirement — including Medicare premiums, copayments, deductibles and prescription drug costs.

If you start planning, the HSA can be a great source of tax-free money for those expenses and more. So don’t pass up the triple tax benefits of an HSA.

Save more in an HSA for out-of-pocket costs

You can’t make new contributions to a health savings account after you enroll in Medicare. But you can contribute to the account before then if you have an HSA-eligible health insurance policy, whether through your employer or on your own.

In 2023, the policy must have a deductible of at least $1,500 for self-only coverage or $3,000 for family coverage. You can contribute up to $3,850 in 2023 if you have self-only insurance coverage or $7,750 for family coverage, plus an extra $1,000 if you’re 55 or older. Plus, many employers contribute to employees’ accounts — an average of $870 for Fidelity’s employer plans.

You have until the tax-filing deadline to contribute to an HSA for the previous calendar year. That means you have until April 18, 2023, to make tax-deductible HSA contributions for 2022. To qualify, your health insurance policy must have had a deductible of at least $1,400 if you had single coverage or $2,800 for family coverage in 2022. You can contribute up to $3,650 if you had coverage for yourself or $7,300 for family coverage, plus an extra $1,000 if you were 55 or older.

If you had an eligible high-deductible health insurance policy only for the first few months of the year, your contribution limit will be prorated based on the number of months you had the eligible policy.

Tax-free withdrawals for Medicare expenses

You’re not taxed on HSA money you use to pay out-of-pocket medical expenses at any age, such as your health insurance deductibles, copayments and costs for prescription drugs, as well as over-the-counter medications. You can also take tax-free withdrawals for other eligible expenses that insurance doesn’t cover, such as dental workhearing aids and vision care.

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And you can withdraw money tax free to pay eligible long-term-care insurance premiums, with the amount based on your age. In 2023, for example, those amounts are:

  • $480 for age 40 or younger.
  • $890 for ages 41 to 50.
  • $1,790 for ages 51 to 60.
  • $4,770 for ages 61 to 70.
  • $5,960 if you’re older than 70.

The biggest benefit for retirees: After you turn 65, you can also withdraw money tax free from the HSA to pay Medicare premiums for you and your spouse for Part BPart D and Medicare Advantage plans.

However you can’t use HSA premiums for Medicare Supplement Insurance, the extra health insurance also called Medigap that you can buy from a private company to pay some health costs Medicare doesn’t cover, such as copayments, deductibles and emergency health care if you travel outside the United States.

These costs can add up: The Fidelity study found that the average 65-year-old couple pays more than $120,000 in premiums for Part B and Part D during their lifetimes. If you’re automatically paying Medicare premiums from your Social Security benefits, you can withdraw money tax free from your HSA to reimburse yourself for these costs. Be sure to keep records of the premiums you paid.

After you turn 65, you can also withdraw money from the HSA for nonmedical expenses without incurring a 20 percent penalty, but you’ll have to pay taxes on those withdrawals. If you plan carefully and keep good records, you should have plenty of opportunities to withdraw the money for HSA-eligible expenses and avoid the tax bill, says William Stuart, author of HSAs: The Tax-Perfect Retirement Account. 

“In the worst-case scenario, the tax treatment is no different from a tax-deferred 401(k). And it can be better if you can withdraw the money tax free,” he says.

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A strategy to build up more tax-free money

A quirk of the HSA rules gives you an unlimited amount of time to withdraw money tax free for any eligible expenses you incurred since you opened the account. If you use other cash for those expenses at the time, you can leave the money growing in the HSA for the future and then withdraw it tax free anytime.

“It’s always best to leave your funds to grow tax free and reimburse yourself later. And it’s even better if you are investing your funds in the meantime,” says Roy Ramthun, president of HSA Consulting Services.

If you plan to keep money growing in the account, make sure your investments match your time frame. Most HSAs let you invest in a portfolio of mutual funds for long-term growth, in addition to offering a savings account for short-term expenses.

Keep records of all HSA-eligible expenses you paid out of pocket through the years. You can look up eligible expenses in IRS Publication 502 Medical and Dental Expenses. Additionally, over-the-counter drugs and menstrual products are eligible for tax-free HSA withdrawals but are not tax-deductible medical expenses.

You can also make tax-free HSA withdrawals to pay your health insurance premiums if you lose your job and are receiving unemployment benefits or if you continue your employer’s coverage on COBRA, a federal law that requires companies with 20 or more employees to let you keep your coverage for up to 18 months after you leave your job. You usually have to pay both the employer’s and the employee’s share of the premiums on COBRA.

Steven Hamilton, an enrolled agent in Grayslake, Illinois, who is authorized to represent taxpayers in front of the IRS, recommends holding on to receipts of the eligible expenses and the explanation of benefits from your insurance company, as well as records showing that you didn’t deduct the expenses on your income tax return or withdraw the money for those costs from your HSA. IRS Form 8889 reports HSA distributions each year. Some HSA administrators, such as Fidelity, provide tools that make it easy to keep track of your eligible expenses and if you paid for them with money from the HSA.

If most of your savings is in tax-deferred accounts such as traditional IRAs and 401(k)s, being able to withdraw money tax free from your HSA, like your Roth IRA, can help you use both types of accounts to lessen your tax bill. The money you withdraw from an HSA for qualified medical expenses isn’t included in the income calculations that determine whether you’re subject to the Medicare high-income surcharge or if you have to pay taxes on your Social Security benefits.

This story, originally published June 16, 2020, was updated with 2023 information.

Kimberly Lankford is a contributing writer who covers personal finance and Medicare. She previously wrote for Kiplinger’s Personal Finance magazine, and her articles have also appeared in U.S. News & World Report, The Washington Post and the Boston Globe. She received the personal finance Best in Business award from the Society of American Business Editors and Writers.

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