Using a health savings account for medical expenses in retirement

By Chris Nolt

A health savings account (HSA) offers a triple tax benefit. It is the only vehicle enjoying both the benefit of tax-deductible contributions, tax-deferred growth plus tax-free distributions (for medical expenses). 

Given the inevitability of medical expenses in retirement, arguably the best account for a portion of retirement savings is an HSA. It is even better than an individual retirement arrangement (IRA) because you only receive two tax benefits with an IRA. A Traditional IRA offers a tax deduction on the contribution plus tax-deferred growth but all distributions are taxed as ordinary income. A Roth IRA offers tax-deferred growth and tax-free distributions but the contributions are not deductible. 

This doesn’t mean you should exclusively fund a health savings account for retirement, as the accounts are both taxable and potentially subject to penalties if used for non-medical purposes. But, for those who already have some retirement accounts and/or have more than enough dollars overall to achieve their goals, the fact remains contributing the maximum to an HSA every year has the potential for more beneficial tax treatment than any other type of tax-preferred account. 

Health savings account rules

Contributions to a HSA are pre-tax (either tax deductible if contributed directly, or excluded from income if contributed by an employer on behalf of an employee). Withdrawals from an HSA for qualified medical expenses are tax free (although non-qualified withdrawals are taxable as ordinary income plus a 20 percent penalty tax, with the penalty waived for those over age 65, who are disabled or if withdrawn as a non-spouse beneficiary after the death of the HSA owner).

Qualified medical expenses are generally any expenses which would otherwise be eligible for the medical (and dental) expenses deduction, along with any expenses paid for a doctor-prescribed drug. Qualified medical expenses also include insurance premiums for health insurance coverage under Continuation of Health Coverage, health care coverage while receiving unemployment compensation, Medicare (but not Medigap) premiums and even a portion of long-term care insurance premiums.

To contribute to an HSA, you must be covered under a High-Deductible Health Plan, not be enrolled in Medicare or other health coverage nor claimed as a dependent on someone else’s tax return. A “high deductible” health plan must have a minimum deductible of $1,400 for self-only coverage or $2,800 for family coverage (in 2022) and can have a maximum out of pocket expense (deductibles and co-payments but not premiums) as high as $7,050 for an individual or $14,100 for a family (in 2022).

In 2022, the maximum contribution limit to an HSA is $3,650 for an individual, or $7,300 for a family, plus a $1,000 “catch-up” contribution for those over age 55 (unlike retirement accounts, where catch-up contributions apply beginning at age 50).

Tax treatment of contributions and distributions of HSAs

There is no time limit on when funds in an HSA must be used. An HSA does not have a “use it or lose it” provision like the Flexible Spending Account where anything more than $500 of unused funds are forfeited at the end of the year. Instead, as long as they were permitted to be contributed into the HSA in the first place, HSA funds can remain in the account for an extended period of time.

In turn, the only requirement at the time of distribution for tax-free treatment from an HSA is that the withdrawal either cover a current medical expense or be used to reimburse a prior one (that was itself paid out of pocket, was not reimbursed from another source and was not previously claimed as an itemized deduction). This means medical expenses can occur now and be reimbursed later (even far later) in the future and still be qualified, as long as documentation of the medical expense is maintained and as long as the medical expense occurred after the HSA was originally established. Alternatively, this means funds can be contributed now to an HSA and grow tax-free for years or even decades before being used (tax-free including all those years of growth) for a distant future medical expense.

Even further extending the favorable deferral period for an HSA, the rules stipulate if the HSA is not used before death, a surviving spouse can continue the HSA in his/her own name and continue the preferential tax treatment (including future tax-free withdrawals). This form of HSA spousal rollover is similar to that permitted for retirement accounts.

Chris Nolt is an independent, fee-only registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement.  To order a copy of Chris’s new book “Financial Strategies for Selling a Farm or Ranch,” visit Amazon.com or call Chris at 800-517-1031. For more information, visit solidrockproperty.com or solidrockwealth.com.