By Justin Fundalinski, MBA | December 22, 2017

HSAHealth Savings Accounts (HSAs) are very interesting from a tax perspective.  Compared to well-known retirement account types (for example – 401k, IRA, Roth IRA, etc.)  HSAs are the only accounts that are tax deductible in the year you contribute to them, that have tax free growth as you defer them, and are tax free when you withdraw from them. They are what we call “triple tax-free.”  Unfortunately, far too many people do not recognize the benefits of these accounts from a tax perspective and how they can be used to generate tax advantages in the future. This month’s article will address the basics of what an HSA is as well as some general planning points that should be considered when using an HSA.

The Common HSA Approach:              

A very standard approach of a HSA is to use it as a means to fund current medical expenses in a tax free manner.  Most often people place money in a HSA account on a tax free basis and then withdraw it tax free shortly thereafter (relatively) when health expenses are incurred.  While this method is better tax treatment than using a normal medical expense tax deduction (which is limited to 10% of your Adjusted Gross Income), it is not necessarily the best way to take advantage of HSA tax benefits because it only takes advantage of two of the three tax benefits associated with these accounts and forgets about one of its greatest advantages – tax free growth.  As we know, growth takes time and the HSA is not allowed the time to grow this benefit if forgone.

HSAs for the Long Run:

HSAs should be earmarked for medical expenses, however unlike their Flexible Spending Account (FSA) counterpart, HSA contributions are not “use it or lose it” come January 1st.   There is no expiration date on HSA contributions and the funds can remain in the account for an extensive period of time[1]. Fortunately (or maybe unfortunately) medical expense are pretty much guaranteed to be a large part of future retirement expenses and just like we save for future expenses in retirement in accounts like IRAs or 401(k)s, we should save for future medical expenses in HSAs.  Saving in an HSA for an expense that is far into the future allows you to take advantage of the “triple tax-free” aspect of these accounts.

HSA Distributions:

If you withdraw funds that do not qualify as medical expenses you will pay ordinary income taxes on these funds, and if you are not older than age 65 when this “non-qualified” withdrawal occurs there is also a 20% penalty.  Wait – did you read that right? The penalty only occurs if you are younger than 65?  That’s right! So, even if you didn’t use it for medical expenses you could still benefit from the tax free growth similar to how a Traditional IRA works minus those pesky RMDs[2].

Of course, it would be better to use it for medical expenses and avoid taxes entirely, but if you already appreciate the value Traditional IRAs bring to retirement planning, viewing HSAs from this stand point emphasizes that tax deferred growth maybe your worst case scenario as long as you can defer withdrawals beyond age 65.  Considering this, I could easily argue that in many cases it would make more sense to max out an HSA before you max out other retirement accounts because of the high potential that medical expenses will occur throughout retirement and the “triple tax-free”  benefit will then be taken advantage of.

No Time Frame on Qualified Medical Expenses

Strangely enough, under current law, there is no time frame as to when qualified medical expenses need to be incurred compared to when the withdrawal from an HSA must occur. That is, if a medical expense was incurred this year but an HSA owner waited to take the distributions from the HSA for 20 years this would be perfectly acceptable as long there is proof of the expense and no tax deductions had been taken on the expense previously.  Extrapolating this loophole, one could essentially save all their medical receipts for the next 20 years and then take one large distribution completely tax free.  Why isn’t everybody doing this?!?!

The Downsides:

To avoid this article dragging on too long, I am going to sum up the downsides of using HSAs as a retirement vehicle in a few bullet points:

  • One needs to have enough income year over year to be able to not only fund the HSA but also pay for any medical expenses that pop up along the way (remember we don’t want to use the HSA in the short term)
  • One has to be in a high deductible medical plan to be eligible for an HSA. This means one must forgo other medical plans that do not have high deductibles (although these types of health plans often have much higher premiums [i.e. HMOs and PPOs], so this may not be that much of a deterrent depending the particular situation).
  • As (foot)noted, at death these accounts may not be very income tax friendly to the beneficiary. If the HSA passes to anyone other than the original HSA owner’s spouse, the account ceases to be a HSA and while the 20% penalty no longer applies this is a distribution that is considered taxable income.


[1] Withdrawals can be deferred for the lifetime of the account owner and the account can continue to exist after death of the original owner because a surviving spouse can step in and continue the account in their own name.

[2] Keep in mind there is far different treatment of these accounts upon death compared to IRA’s. If the HSA passes to anyone other than the HSA owner’s spouse, the account ceases to be an HSA and while the 20% penalty no longer applies this is a distribution that is considered taxable income.