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Using Your HSA as a Retirement Investment Vehicle

Written by Nickel - 38 Comments

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 - 38 Comments
Filed under: Insurance, Saving & Investing, Taxes

About the author: 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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38 Responses to “Using Your HSA as a Retirement Investment Vehicle”

  1. 1
    Mr. GoTo Says:

    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.

  2. 2
    Floridian Says:

    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 ;)

  3. 3
    Ryan B Says:

    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.

  4. 4
    daddy paul Says:

    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.

  5. 5
    Blaine Moore Says:

    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.

  6. 6
    Early Retirement Extreme Says:

    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.

  7. 7
    Rae Says:

    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.

  8. 8
    Hildebrand, The Insurance Warden Says:

    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?

  9. 9
    Frugal Babe Says:

    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)

  10. 10
    nickel Says:

    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.

  11. 11
    Stacey Says:

    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.

  12. 12
    Funny about Money Says:

    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.

  13. 13
    Anthony Says:

    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.

  14. 14
    Anthony Says:

    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.

  15. 15
    Ben Says:

    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.

  16. 16
    Jonathan Says:

    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!

  17. 17
    Paul Says:

    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.

  18. 18
    Nathan Says:

    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.

  19. 19
    Tom Says:

    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?

  20. 20
    Nickel Says:

    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.

  21. 21
    Curious Says:

    But also on page 8, it defines “qualified medical expenses” as those defined in 502.

  22. 22
    gerard Says:

    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.

  23. 23
    goofy Says:

    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.

  24. 24
    Carla Says:

    I did read the information that was recommended by Nickel and Curious and just wondering if you know how the 1040x form is going to affect my income taxes in the future?

  25. 25
    Andrew Says:

    So who offers the best deal on an account you would use for this purpose? You would want to have mutual funds or ETFs with very low expense ratios. You also want low administrative fees.

    I am a big fan of Vanguard so I checked their site. They don’t appear to directly offer HSAs but they direct you to a place where you can get Vanguard funds through a company called Health Savings Administrators. They charge an account setup fee of $20, an annual fee of $39, plus a small custodial fee of 0.0008 per quarter (only on the first $20k in the account.). To transfer the account away from them they will charge you $25.

    Has anyone else found a better deal than the Vanguard-related one above?

  26. 26
    Sue Says:

    Has anyone else found a better deal than the Vanguard-related one above? ABSOLUTELY!

    Check out Credit Unions which pays interest on the account though HSAs at my Credit Union have just begun getting slammed with a $3/month account fee. Even with the $3 fee, my dormant account continues to grow instead of shrinking as it did at Mellon Bank.

    Note: Dormant account growing tax-free; hence I paid out-of-pocket to preserve these monies. Plan is to use if/when long term care needed with a 60 day window of self-pay.

  27. 27
    Lory Says:

    HSA is not for people who have medical issues. My husband and I were forced into a HSA through his employment..to save them money. We can not save money while having to pay full cost for prescriptions, xrays, doctor appointments, 50% of our Insurance premium, ect. HSA’s are for people with high income not the average wage earner!

  28. 28
    Kevin Hohenbrink Says:

    I am looking to switch to an HSA the first of 2013 for the investment and tax benefits you mentioned in your blog.
    My question is my wife has a PPO plan at her work that I can join. We would like to use her plan for our medical expenses and use my HSA HDHP only for the investment and tax advantages. Is this legal?

  29. 29
    Darren Says:

    I’ve just moved to a new employer, and have access to an HSA for the first time. This has caused me to do research:

    To answer your question:
    “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?”

    If I were in that position, and hadn’t yet maximized my IRA contributions that year – I would certainly consider taking the distribution for a qualified medical expenses from the HSA and contributing that amount to a Roth IRA.

  30. 30
    Karen Says:

    I am a customer of Health Savings Administrators and they have changed their fees from the post above. There is no setup fee, only an annual fee of $45. They are still the only HSA where you can invest in Vanguard Funds with no minimum investment.

  31. 31
    Sandeep Says:

    OptumHealth bank HSA has Vanguard funds.

  32. 32
    Hman Says:

    @ #27

    I disagree with the assessment of HSA being for wealthy or for those w/o existing health conditions.

    Using HSA funds for out-of-pocket medical expenses (including deductibles) is a brilliant way to use pre-tax funds in what would otherwise be paid with post-tax cash. That is a significant benefit for all wage earners.

    HSA should be seen as a hedge for the sting of HDHP’s deductible & other uncovered medical expenses, on a tax-free basis. Financial benefit is HSA monies fill the gap of uncovered incidents, thus the hedge.

    Best of all, if your employer’s HDHP offers lower premiums than a PPO/HMO plan (assuming your employer provides choices) you might save significant guaranteed expenses if you are not a big health consumer. Either way, HSA is the smartest way to provide funds to pay for those out of pocket items that you wouldn’t be exposed to with higher premium insurance plans with more generous coverages.

    In other words, higher premium plans – you are in essence ‘pre-paying’ for coverage you may never use. With HDHP you lower your premiums and and leverage HSA for the differences. If you don’t happen to use HSA funds in say 2013, great! That means that money is still there in 2014 and you don’t have to add additional contributions! winwinwin

  33. 33
    bruce Says:

    I got into my “career position” when I was 24. For the first two years I just signed up for a cheap health insurance plan because I never went to the doctor, I wish I would have known then about HSAs. Close to the end of my second year enrolled in a HSA, I’ve only used it one time when I went to the dentist. I have a couple thousand in there and I have yet to make out of pocket contributions to the account. That will soon change. I’m 28 years old and still don’t go to the doctor (except my free annual exam covered by my doctor). If this trend keeps up for another five to ten years, I should have a nice chunk of change set aside in case something major happens. Long term, if I’m able to stay healthy, this will be a nice safety net retirement account when I turn 65 (the age when you can withdraw funds from the account for non-medical expenses without penality). I really like the concept of HSA/high deductible insurance. It’s not for everyone but for those who it works for, you don’t get so frustrated about the thousands and thousands of dollars you pay to an insurance company and never see again.

  34. 34
    Nightvid Cole Says:

    How could it EVER make sense to withdraw money for non-health expenses after age 65 and pay taxes? Shouldn’t you use “regular” retirement savings for non-health expenses in retirement and the HSA for health expenses in retirement, to minimize your taxes? Unless you have SO MUCH money in it that you are unlikely to have to spend that on health care in the entirety of your remaining life – seems unlikely unless you have $400,000+, given the problems with Medicare…

  35. 35
    Kelly Says:

    I’m considering using all my HSA to fund paid up additions on my cash value whole life insurance to increase my retirement supplement every year. Good idea?

  36. 36
    Dan Says:

    I am hoping to leave my HSA money to my kids. Is that a good idea? Does anyone know what happens to an HSA after death of the owner?

  37. 37
    Tom Says:

    @Dan- If you die, the plan can transfer tax free to your spouses HSA plan- assuming you have him/her as the named beneficiary. If not or no spouse, then it simply goes to your estate and will be taxed at ordinary income. You can’t ‘leave’ the HSA to your kids, but you can leave your estate to them of course. However, if you were to die, there may typically be medical expenses to pay by the trustee if you have a trust or simply the executor of your will before distributing excess and after paying taxes on your final tax return. That money should be used for the medical first of course.

    Have to agree with the concept of investing it and using personal money as much as possible over the long term for tax free growth. Don’t use it for $20 co-pays or cheap prescriptions (get your doc to use Costco and don’t run it though insurance and you can get 90 day prescriptions much cheaper) but bank the money for when something large comes up and you really don’t have the money or it will put you in a temporary bind.

    One of the best concepts is once you have built up enough to cover say 3 years max out of pocket you can use the funds to buy long term health coverage. This is farily cheap before 50-55 and if you ever need it in later in life (talk to older people about the cost of in-home or nursing home care!) this will be a nice tax free way to buy the coverage. A couple hundred a month could save you several thousand a month in your later years. The ROI on that tax free is priceless.

  38. 38
    Dan Says:

    TY for the update, Tom. So, I named wife as beneficiary, and vice versa. We can pay for our current health care, we are luckily in pretty good shape. When we retire and our income stream stops, this will come in handy. Also, we are going to keep a file with our medical bills which we paid for out of pocket since opening our HSA’s, see if we can cash in later on, when we may need the money. Big help, TY again.

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