Health Savings Accounts: A Smart Way to Save for Retirement

Steve Merrell |

Q: I contribute every year to a health savings account and use it to help pay for medical expenses before I reach my deductible. Recently someone told me that they use their HSA to save for retirement, kind of like an IRA. I’m not sure exactly how that works, but is it a good idea? Is it better to use the money now or save it for later?


A: The original intent of the legislation that created HSAs (and their predecessor, medical savings accounts) was to help individuals and families pay for the day-to-day medical expenses not covered by their high-deductible health plans. It didn’t take long, however, for people to realize that HSAs were a great way to put money away for retirement. In fact, in many ways, HSAs are the best retirement savings vehicle going—even better than Roth IRAs. Here’s how the HSA works.


Not everyone can contribute to a health savings account. In order to even play the game, you must first be covered by an HSA compatible health plan. If you are on Medicare, you are out of luck. You are also disqualified if you are eligible to be claimed as a dependent on another person’s tax return.


If you are eligible, IRS rules say you can contribute up to $3,600 to your HSA in 2021 if you are an individual. Families can contribute up to $7,200. In 2022 the limits increase to $3,650 and $7,300 for individuals and families, respectively. In addition, individuals who are 55 or older by the end of the tax year, get a $1,000 catch up. Contributions need to be made by the annual tax payment deadline.


HSAs are attractive because they deliver three powerful tax benefits.


Tax Benefit #1: HSA contributions are made on a pre-tax basis. This means the money you put into your HSA reduces your earned income dollar-for-dollar on your federal tax return. Unfortunately, contributions are not deductible on California state tax returns.


Tax Benefit #2: Just like an IRA, HSA investments grow tax-free. At current tax rates, assuming you invested your HSA in a good S&P 500 index fund, tax-free growth could add as much as 15 percent to your ending account balance over a 25 year period compared to a taxable portfolio.


With these first two tax benefits, the HSA behaves a lot like a traditional IRA. It is the addition of the third tax benefit that makes the HSA really special.


Tax Benefit #3: If you withdraw money from your HSA to pay or reimburse qualified medical expenses, your distribution is tax-free. You can defer distributions to pay for this year’s medical expenses to later taxable years. You can also use distributions from this year to pay for medical expenses from previous years. The only condition is that the medical expenses had to have been incurred after the HSA was established.


By now you can see why some people refer to HSAs as “stealth IRAs.” Though they were not originally intended to be retirement savings vehicles, they are one of the best retirement savings opportunities around.


When it comes to deferring HSA distributions into the future, the IRS gives one very important caveat: “[Beneficiaries] must keep records sufficient to later show that the distributions were exclusively used to pay or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from


another source and that the medical expenses have not been taken as an itemized deduction in any prior tax year.” (IRS Notice 2004-50)


This final caveat may seem daunting. The IRS clearly puts the burden of proof on the beneficiary to show they qualify for the third tax benefit. However, if you keep receipts and tax records, it should be easy to support your claim should the IRS ever challenge you.



Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to