Are HSAs the New IRAs?

February 12, 2023
These triple-tax-advantaged accounts could help pay for health care in retirement.

Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) both allow you to set aside pre-tax funds to pay out-of-pocket qualified medical expenses1—including co-insurance payments and deductibles, dental and vision care, prescriptions, and many other health-related items. However, only HSA funds can be used in retirement, among other differences.

Here are some ways that HSAs compare to FSAs and how best to take advantage of an HSA's benefits.

You own the account and the funds in it

Your eligibility for an HSA or an FSA depends on if you're employed (and what your employer offers if you are) and what kind of health plan you're enrolled in. For example, self-employed individuals aren't eligible for FSAs, and only people enrolled in an eligible high-deductible health plan2 (HDHP) can contribute to an HSA. 

An HSA is yours to keep indefinitely, even if you change jobs or retire—a notable advantage over FSAs. At the end of the year, unspent funds carry over, and the money remains in your account until you use it. You can also continue contributing to your HSA as long as you're not enrolled in Medicare and are covered by an eligible HDHP. 

An FSA, on the other hand, is owned by your employer, and you lose the account and forfeit any unspent money when you leave your job. FSA funds often don't roll over to the new year either—with the exception of either a short grace period or small carryover amount. Otherwise, any balance at the end of the plan year is returned to your employer.

You can save for retirement

As the name suggests, an HSA is a savings account where your money earns interest. And once your balance achieves the minimum threshold set by your plan, you can invest funds you don't expect to need immediately, making an HSA a highly effective tax-advantaged strategy for medical expenses in retirement.

An HSA offers a way for you to sock away triple-tax-free money for health care costs in the future. Here's how:

  • Contributions to an HSA may be tax-deductible.3
  • Interest on your account balance and capital gains and dividends on your investments accumulate tax-free.4
  • You pay no tax on withdrawals for qualified medical expenses.

Typically, you can't use your HSA to pay for health insurance premiums. The good news is that you can use your funds to cover premiums for long-term care insurance and for many Medicare expenses, so consider contributing the maximum amount each year as part of your retirement planning strategy.

You can use your HSA for retirement income

Although you should use your HSA to cover medical expenses, you could use the funds as an additional source of income in retirement. If you use HSA funds for non-medical expenses after age 65, you'll pay only ordinary income tax—a tax hit no worse than you would expect from an IRA withdrawal. Be aware, however, that using funds on non-medical expenses before age 65 would leave you paying both ordinary income tax and a 20% penalty. If you're not yet retired, speak with a financial planner or tax advisor before making a move.

1Defined as those that would generally qualify for the medical and dental expense deduction in Publication 502. Reimbursements to yourself for qualified expenses can occur any time as long as these expenses were incurred after you established your HSA.

2Defined as those with a minimum annual deductible of $1,500 for individuals and $3,000 for families and maximum out of pocket amounts of $7,500 for individuals and $15,000 for families. Enrollees can't be enrolled in Medicare, claimed as a dependent on someone else's tax return, or covered by another health plan without a high deductible.

3While HSA contributions are exempt from federal income tax, they are not exempt from state taxes in California and New Jersey.

4State taxes may vary.

Learn more about health care planning.

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Medicare premiums can jump sharply if your retirement income rises above certain levels, but there are steps you can take to prepare and minimize the impact.

This information is not intended to be a substitute for specific individualized tax, legal, or investment-planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

Investing involves risk including loss of principal.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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