How to Use a Tax-Saving Health Savings Account in Retirement

By David Conti | Originally posted on NextAvenue

5 things to know to use an HSA to pay for medical expenses

A Health Savings Account (HSA) lets you save money in a tax-advantaged account and then withdraw cash tax-free to pay for qualified medical expenses. Often, the money is used while you're working. But you can also use your HSA in retirement to help lower your out-of-pocket medical costs then. Doing so could help stretch your retirement savings, too.

"While no one can predict what their health care costs will be in the future, we estimate that health care costs will rise four percent annually, so the numbers can get daunting pretty fast," says Kevin Webber, a wealth adviser at Heritage Financial in Westwood, Mass. "HSAs can give clients some control over their tax bill when deciding how to pay those health-related costs."

A Definition of Health Savings Accounts

Before explaining how best to use an HSA in retirement, a brief definition:

In 2021, you can put up to $3,600 in pre-tax money ($4,600 if you're 55+ and $7,200 for a family or $8,200 for a family if you're 55+) in an HSA. Earnings from its investments aren't taxed; neither are withdrawals for qualified medical expenses. But to qualify for one, you must have a high-deductible health insurance plan — one with a minimum deductible of $1,400 for an individual or $2,800 for a family. (Roughly 35% of employers offer high-deductible plans, according to Bank of America.)

Before age 65, if you use HSA money for a non-qualified medical expense, you'll owe a 20% tax penalty on the amount of your withdrawal and the money you take out for that expense will be taxed as ordinary income.

You can't continue contributing to an HSA once you're on Medicare; if you do, you'll owe tax penalties.

After you die, your spouse or partner can inherit your account and turn it into their own HSA. But any money your children inherit from your HSA will be fully taxable.

Some 30 million Americans are using HSAs, says Jon Robb, senior vice president at Devenir, an HSA investment firm based in Minneapolis. Yes only 45% of people who may qualify to open an HSA have actually opened one, according to the University of Michigan's Institute for Healthcare Policy & Innovation.

On average, HSA holders older than 50 had an average HSA balance of over $4,300 in 2020. According to Fidelity Investments, the average HSA owner holds over $8,900 in it at age 65 and $8,400 in one at 70.

Although that's a drop in the bucket compared to the estimated $300,000 the average 65-year-old couple will need for health care, it's a nice start.

Here are 5 ways you can use an HSA during retirement: