If you’re part of the at least one in five Americans who are covered by a Health Savings Account (HSA), hopefully you’ve realized the potential power of the HSA as a significant wealth-building tool. However, as we’ve learned from countless conversations with clients, most HSA account holders are not yet fully aware of all of the nuances involved in fully optimizing this powerful little account.
When best practices are used over the years, you can easily accumulate over six figures in your account. Which, when paired with the fact that future healthcare expenses are one of the biggest unknowns in most financial plans, having a pot of tax-free money set aside specifically to cover those expenses can make tax and withdrawal planning in retirement much simpler.
Under the current tax law, HSA contributions are not allowed when any other coverage is in place, including Medicare, so getting this planning tool right during your working years is key. But even if you’re only a few years out from joining Medicare, you can still accumulate a decent amount in your HSA to offset future healthcare costs, so read on.
These are five lesser-known facts about HSAs that many people don’t know, which are also key to making the most of this important retirement planning tool.
1. There is no statute of limitation on HSA reimbursements
Arguably the most important fact you need to know about HSAs, this one is the primary key to unlocking the true potential of the HSA. Not only can the money in your account be saved up over the years to pay for medical expenses incurred later in life, but they can also be distributed as reimbursement for prior-eligible expenses paid out of regular savings. With no limit on when you reimburse yourself.
To give yourself the most flexibility with future HSA withdrawals, it’s a best practice to keep an ongoing record and receipts for every eligible expense incurred, including little things like over-the-counter medicines, menstrual products, sunscreen and other everyday expenses that most people don’t consider to be medical expenses. This expands the tax-planning feature of the HSA in retirement to include the ability to withdraw funds for non-medical expenses when needed.
For example, let’s say you have a balance of $200,000 in your HSA, but have very low medical expenses anticipated in the coming years. As long as you also have a record of the years of medical expenses incurred throughout your working years since starting the HSA, withdrawals can be made against those as reimbursements. Suddenly that unplanned home repair project doesn’t have to lead to a taxable retirement account withdrawal that pushes you into a higher tax bracket.
Keep in mind that the burden of record-keeping with HSAs is your sole responsibility, so finding a way to save receipts over the years to justify future withdrawals in case of an IRS inquiry is important.
2. All future expenses are eligible, regardless of enrollment when incurred
Once your HSA is established, meaning you’ve deposited at least $1 into the account, any future expenses incurred are eligible for reimbursement from the HSA as long as the account exists.
In other words, let’s say you first enrolled in an HSA-eligible plan during your healthier 20’s and 30’s, you put the maximum eligible contribution into your account each year and then left the funds invested for long-term growth, while tracking any money you did spend from your savings on eligible expenses.
As you approach midlife and have some medical issues pop up, you switch to a lower deductible plan so that your insurance can share in more of your costs. However, you should continue to track your out-of-pocket spending and save receipts for future reimbursement (or you can use your HSA funds for those expenses if the alternative would be accruing high-interest rate debt).
It's true that you are not able to make further contributions to the account when you switch to a non-HSA-eligible plan, but the out-of-pocket costs incurred can still be paid out of the HSA. Once an HSA is established and funded, it should be a habit to track expenses for future withdrawals unless or until your HSA is fully depleted.
3. One-time IRA to HSA rollover
Called a qualified HSA funding distribution, you actually have the ability to take a once-in-a-lifetime IRA distribution and roll it directly into your HSA in a tax-free transfer, up to the annual contribution limit for HSAs in the year of the transfer. The rules here are a bit sticky, including the need to remain eligible for HSA contributions for at least 12 months after the transfer, so be sure to check the rules and work with your financial professional to make sure you don’t run afoul of the rules.
The ideal time to perform this once-in-a-lifetime rollover would be between ages 55 and 59, when you’re eligible for the HSA catch-up contribution and not yet able to make penalty-free IRA withdrawals. Just make sure you’re still enrolled in an HSA-eligible plan when doing it and plan to do so far at least the next 12 months.
4. HSAs can be used to pay certain insurance premiums
While HSA funds cannot be used to pay for health insurance purchased through the government marketplace, there are other insurance premiums that can be paid from your HSA.
The first is COBRA, or health care continuation coverage as defined by the IRS. Along the same lines, if you are collecting unemployment, then any healthcare coverage premiums are also eligible, but you also then forgo the ability to claim any tax credits or deductions for that coverage, so you’ll want to weigh the financial benefits there.
The IRS also allows HSA distributions to cover Medicare premiums, like for Parts B and D (although supplemental policies are not eligible).
Finally, premiums paid for long-term care insurance are also eligible HSA expenses, within certain limits based on your age in the year you paid the premium.
5. HSAs are not subject to probate
HSAs are technically considered trusts, meaning they bypass probate and pass directly to your designated beneficiary. Be sure that your HSA is on the list of accounts to review for up-to-date beneficiaries on an annual basis. Note that HSAs are not a tax-efficient way to transfer wealth though.
Naming your spouse as beneficiary will allow them to continue to use the account in its tax-free status for the rest of their life, but when a non-spouse beneficiary is named, an HSA is immediately payable and taxable. In that case, if you have a charitable intent, a best practice would be to name your favorite charity as the beneficiary of any remaining HSA funds, avoiding taxation and leaving other assets to fulfill bequests.
A retirement account with a healthcare benefit
When used strategically, HSAs are an awesome way to realize tax-free investment earnings while also providing a designated, tax-free buffer against future healthcare costs.
And if you happen to overfund your HSA? Good news! Once you turn 65, under the current law, you can actually take penalty-free distributions for non-healthcare expenses, making the HSA more