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Using Your HSA as a Retirement Investment Vehicle
Tip It!As many of you know, we switched to a high-deductible health insurance plan (HDHP) this year. Along with that change came the opportunity to open a health savings account (HSA) to help offset our increased deductible.
For those that are unaware, an HSA is similar to a flexible spending account (FSA), but better. While both provide a tax break on qualified medical expenses, the HSA has a higher annual contribution limit ($6150 for families, $3050 for individuals) and it’s also not subject to the “use it or lose it” provision.
Another very important difference is the freedom to invest funds in an HSA in much the same way you can invest the money in your IRA. While your employer might have a “preferred” HSA custodian, you can actually use an custodian you want.
A better use for our HSA?
All of this got me to thinking… Assuming that you can afford to pay for their medical expenses out-of-pocket and make HSA contributions, should you make claims against your HSA? Or should you leave the money in place and let it grow, completely tax free?
When you really think about it, the HSA combines the best attributes of the Traditional and Roth IRAs. That is, it combines the deductible contributions of a Traditional IRA with the tax-free distributions of a Roth IRA. Add to that the high contribution limits and you’re talking about a very powerful investment vehicle.
Getting your money out of your HSA
Obviously, we’ll eventually want to get our money back out of our HSA. How can we do that? Simple. According to IRS Publication 969:
When you pay medical expenses during the year that are not reimbursed by your HDHP, you can ask the trustee of your HSA to send you a distribution from your HSA.
The go on to say that:
You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA… You do not have to make distributions from your HSA each year.
(emphasis added)
But wait… It gets better:
If you are no longer an eligible individual, you can still receive tax-free distributions to pay or reimburse your qualified medical expenses.
One other little safety net is that, once I turn 65, the 10% penalty for non-qualified distributions goes away.
Here’s a quick translation:
- You can take distributions in return for any qualified medical expense that you incur after open your HSA
- You are free to wait as long as your want to take these distributions
- You can even take distributions after you’re no longer eligible to contribute to an HSA
- You can also claim qualified expenses incurred after you lose eligibility
- Once you turn 65, you can take non-qualified distributions by paying taxes (like a Traditional IRA) without paying the 10% penalty
Of course, you’ll have to save your documentation to make this happen. The good news is that you can simply scan and archive the paperwork (just be sure to keep backups!) as the IRS accepts scanned documents.
Your thoughts
So, dear readers, what do you think? If you’re in a position to cover the out-of-pocket expenses associated with your healthcare while contributing to an HSA, should you take distributions from your account? Or should you leave those funds in place to grow tax free such that you take better advantage of them in the future?
As for us, leaving the money in place is a pretty attractive proposition, and we’re currently archiving receipts instead of taking distributions while we consider our options.
N.B. It seems like I’m not the only one that thinks this way.
Published on February 22nd, 2010 - 23 Comments
Filed under: Insurance, Saving & Investing, Taxes
About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!
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23 Responses to “Using Your HSA as a Retirement Investment Vehicle”
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February 22nd, 2010 at 8:35 am
I agree. With proper investment choices inside the HSA account, using an HSA for retirement investing is better even than a Roth IRA because no taxes are paid either going in or out of the account. For this reason, I haven’t used any of my HSA account to reimburse medical expenses in three years. My account is now well into five figures.
February 22nd, 2010 at 9:48 am
The CPAs caught onto this one really quick! I went to a presentation on the exact same subject a little over a year ago. Good for you for figuring it out without the help of a CPA
February 22nd, 2010 at 10:47 am
I think you’ve got the right idea. I’ve been contributing to an HSA and paying mostly out-of-pocket for medical expenses since around 2000 (technically an MSA back then). There have been periods where I wasn’t covered by a HDHP and had to suspend contributions, but left the HSA alone.
Last year I was able to add a new baby to my HDHP and qualify for higher contribution limits. Now the balance is climbing and I think of the HSA as a medical emergency fund in the short term. Long-term I hope it will be the primary method of paying for medical expenses in retirement.
The greatest concern I have is that sometime during the next 33 years congress puts an end to these plans.
February 22nd, 2010 at 11:20 am
Good read, good topic!
Health Savings Accounts are excellent vehicles. With the job market the way it is today you may or not have the ability to contribute to a HSA for an extended period of time but you can spend it tax free on medical expenses for life. This account lets you save up for kid’s braces, crowns, and the like. I maxed out my account for a year and a half. It took five years but it all got spent. Not only did I make money on the savings Uncle Sam and the State footed the bill for a hefty portion of the expenses since the money was spent tax free. If you reach 65 then you have an investment similar to an IRA. This is a great way to make the most of your money.
February 22nd, 2010 at 1:19 pm
I opened an HSA this year, mostly so that my health costs would be pre-tax rather than post tax. My insurance plan isn’t very good and doesn’t cover much anyway, so I was happy when this became an option.
I never considered using it as a retirement vehicle, but I think for the time being I’ll use it as it was meant to. Perhaps in the future I can change my priorities around.
February 22nd, 2010 at 1:55 pm
I do the same thing starting my HSA+HDHP a year ago.
While the cash flow is negative in th beginning, the earnings from the HSA can quickly exceed health insurance if the tax deduction doesn’t do it already; hence for anyone with $3000 to spare each year, it is a quick way to eliminate health insurance cost. Especially for those who start early e.g. build up their HSA before premiums start growing significantly.
February 22nd, 2010 at 3:21 pm
My employer doesn’t offer a HDHP, sadly, but my partner caught on to this one a while ago and has been doing the same thing (although he doesn’t pay everything out of pocket; he does get reimbursed on occasion). It helps that he has very few medical expenses, but more than once I’ve heard him expounding on the idea of using his HSA as a great additional retirement vehicle. AFAIK, he’s been maxing it out every year and has withdrawn maybe $200 to date.
February 22nd, 2010 at 5:27 pm
Concentrated investment into an HSA looks appealing, but would you provide a couple of answers?
What constitutes a ‘qualified’ medical expense? Does therapy for mental wellbeing qualify?
And by your final bullet-point am I to understand that the entirety of the HSA could be liquidated to supplement a retirement, so long as income taxes are paid on every dollar beyond the principle?
February 22nd, 2010 at 6:34 pm
We switched to an HSA qualified health insurance plan in 2007, and have been maxxing out our HSA ever since. In 2008, we withdrew funds to cover our deductible when my husband had knee surgery, but since then we’ve left it alone, and saved receipts. We’ll finish our 2010 contributions next month (a little ahead of schedule thanks to a tax refund), and plan to just let it keep growing. We absolutely think of it as another retirement account.
Hildebrand, you can check out IRS publication 502 to see what’s considered qualified expenses. Also, since the money you put into an HSA is tax-deductible, everything (principle and growth) is taxable for retirement purposes if it’s liquidated for reasons other than medical expenses (it’s very similar to a traditional IRA, except that you can take money out for medical expenses without paying taxes or penalties)
February 22nd, 2010 at 7:08 pm
Hildebrand: I will likely put something together in the next few days on qualified expenses, but in the mean time you can click through the IRS link in the article above for a summary.
Regarding your other question… Assuming the distribution isn’t for qualified expenses, I believe that taxes would be due on the full amount distributed after 65 (including principle) because the contributions were deductible going in.
February 23rd, 2010 at 11:39 am
We plan on having a baby within the next three years, and my health plan isn’t the greatest. We’re stashing the max in my husband’s HSA every year and plan to use those funds to pay for maternity care.
The best part about an HSA, in our case: My husband has a HDHP through work, but I don’t. We can use his HSA to save for my health expenses!
After the baby arrives, we’ll probably start using the HSA as a beefed-up emergency fund/retirement vehicle.
February 26th, 2010 at 8:35 am
That was the pitch I was given when I was sold an MSA, an early version of the HSA. Terms were the same as you describe.
Problems were as follows:
At the time, we had a limited number of choices of banks that were allowed to administer HSAs. Their fees were exorbitantly high. You had to figure out where you could invest the money, and then you had to manage the investments yourself…and you STILL paid fees that ate up returns. Thus as an investment vehicle, it was a bit of a rip.
Second, unless you’re extravagantly lucky or extravagantly affluent, few people can pay medical bills out of pocket.
Third, the amount we were allowed to deposit in the HSA was less than the annual deductible. Thus if you got sick or hurt in the first 18 months or so after buying into the plan, you would quickly consume every penny you’d set aside.
That said, one advantage was that when doctors learn you’re paying in cash, you can sometimes negotiate fees downward.
February 26th, 2010 at 1:12 pm
FCN has already talked about ONE of the TWO great reasons why I have an HSA: the great tax benefits. You get the tri-facto: pre-tax contributions, tax-free distributions, and tax-free interest/growth.
The SECOND great reason for me: My company contributes $100/month on my behalf. Great deal!
In any case, I am stockpiling money in my HSA for my older years. Not retirement, but the inevitable increased health problems as I age. In the short-term, my HSA acts as an emergency fund for any medical emergencies. I have not been able to max out my contributions, but for the last two years, I’ve built a nice $3000 HSA medical cushion.
February 26th, 2010 at 1:15 pm
Oops… I also want to say:
I didn’t know that my company’s HSA custodian was just preferred and not required. I will have to start exploring options!
I am with ACS|BNY Mellon. I don’t like the investment options that they have. I am curious if anyone has recommendations on HSA custodians with good investment options.
February 26th, 2010 at 9:37 pm
Nickle, very interesting discussion on the savings benefits of HSA accounts. I happen to be someone in the very high income category who can afford to pay for my annual medical expenses out of pocket without dipping into my HSA account. I did not recognize the benefits that this account affords.
I would be very interested to learn more about some recommended HSA custodians that are considered low cost providers. Thanks for the great information.
February 27th, 2010 at 10:44 am
What I noticed about HSA accounts listed in Texas was very poor earning potential. At least that is the case with the ones I found online. Plus, the ones with better earning potential (relative of course) also had higher fees, $3-$5 per month as opposed to “only” $25 per year. Throw into the mix, I can find an affordable HDHP, then the HSA is out. So, until I can lose the weight to be able to even get a policy, no HSA’s for me!
December 2nd, 2010 at 10:07 am
After age 65, I don’t think these funds can be withdrawn tax free like a ROTH. I believe they are taxed like a traditional IRA as income, but not subject to the 10% (moving to 20% in 2011) penalty.
July 1st, 2011 at 11:56 pm
Paul, you’re missing the loophole. If you incur qualified medical expenses throughout the years, pay for them out of pocket, and file claim for these in retirement….there’s your tax-free (like Roth) distributions. They would have to be justified with past qualified (and unreimbursed) medical expenses. The tradeoff is the tax-free, compounded growth.
Great planning idea.
September 29th, 2011 at 2:27 pm
IRS publication 502 dated March 03, 2011 (Page 3) asks “What Expenses Can You Include This Year?” and goes on to answer by saying, “You can [only] include medical and dental expenses you paid this [calendar] year, regardless of when the services were provided.”
So unless I’m missing something that completey kills the idea you recommended, does it not?
September 29th, 2011 at 2:52 pm
Tom: Read the Introduction section on page 2. That publication talks about including your medical expenses as itemized deductions on Schedule A, and thus isn’t relevant to this discussion. Publication 969 is the one that talks about HSAs:
http://www.irs.gov/pub/irs-pdf/p969.pdf
See page 8. You can receive distributions for qualified expenses incurred after the HSA was established.
November 7th, 2011 at 1:38 am
But also on page 8, it defines “qualified medical expenses” as those defined in 502.
January 1st, 2012 at 10:47 am
It’s amazing to me how many of my co-workers have no understanding that by taking a little risk with their medical expenses, they can save a lot of money. Usually the savings in insurance premiums is enough to fund the account with money to pay for the deductible.
Another advantage is that with a hd account, there can technically be no copays. I got zapped with high copay charges when I went on a regular plan for a short period and they did not count as out of pocket. HD spending is all applied to maximum out of pocket.
January 28th, 2012 at 6:18 pm
I am thinking that using the HSA for immediate (pre-retirement) med/dent/prescription expenses may be of more benefit than leaving it all there hoping for investment gains.
Here’s why. Let’s assume a tax rate of about 25% or more, when you combine fed & state income taxes. How much does a ’safe’ investment accrue, maybe 5% or so annually.
So, $1200 in med expenses, you save $300 in taxes, whereas the 5% is $60 earnings. Of course this accrued. Year two pays 5% of $1260, which is $63, etc.
In my mind, put the maximum in ($3050 or $4050), but pay current expenses.