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4 Health Savings Account Benefits That Could Help in Retirement

  • 1. Quadruple tax benefits
  • 2. Delayed withdrawals for medical expenses
  • 3. After 65, penalty-free withdrawals
  • 4. Employer contributions

By Stephen Sellner | Citizens Bank Staff

Have you heard of Health Savings Accounts (HSAs)? If not, you might be missing out on arguably the best savings vehicle that can complement your retirement plan.

An HSA is a tax-advantaged savings account designed specifically for healthcare-related expenses, like copays, prescriptions, and many more. Contributions could grow over time, similar to a 401(k), and funds roll over year to year. But beyond those advantages, HSAs could one day give your retirement savings a big boost, if used smartly.

Here are four reasons why opening an HSA could pay off big time when you’re ready to retire:

1. Quadruple tax benefits

As previously mentioned, an HSA is arguably the best savings vehicle there is. Here’s why:

  • Contributions are tax-free,
  • Contributions are also pre-Federal Insurance Contribution Act (FICA),
  • Growth is tax-free, and
  • Withdrawals are tax-free (if taken to pay for a qualified medical expense).

Before going further, let’s outline the differences between tax-free and pre-FICA contributions. Tax-free contributions are exempt from federal and state tax deductions. However, they aren’t exempt from FICA tax deductions, which include Medicare and Social Security. So, your tax-free contributions to your 401(k) are exempt from federal and state tax deductions, but Medicare and Social Security deductions will still occur. HSA contributions are pre-tax and pre-FICA, so that money is exempt from all deductions.

The four tax benefits listed above make HSAs a huge asset when it comes to affording medical expenses, which, in retirement, are likely to be one of your biggest expenses.

The 2019 HSA contribution limits are $3,500 for individuals and $7,000 for families. You can contribute an extra $1,000 per year starting at age 55.

2. Delayed withdrawals for healthcare expenses

Using tax-advantaged dollars from your HSA funds to cover medical expenses is a no-brainer. But you don’t have to withdraw those funds right away; you can do so later on.

You could pay for medical expenses out of pocket, then make delayed withdrawals from your HSA years later.

Let’s say you’re able to cover your medical expenses out of pocket, without the use of your HSA. You could still contribute money to the HSA to take advantage of its tax benefits, thus giving those funds the chance to grow over the course of time. Years later, when you’re ready to withdraw those funds, use your receipts to justify that the withdrawal is for qualified medical expenses, in case you're audited by the IRS, and get reimbursed for those costs that you previously covered out of pocket.

What’s the benefit of getting reimbursed years later rather than right away? By keeping those funds in the HSA for years, they have more time and opportunity for those funds to grow. Money withdrawn from an HSA immediately doesn’t have as much time to grow in the account.

Consider this example: You discover that you need eyeglasses, which cost $200. You have that $200 in your HSA, so you have a choice:

  1. Withdraw that $200 from the account right away to reimburse yourself, or
  2. Pay the $200 out of pocket, keep the $200 in HSA funds within the account, and hope that years from now, that $200 has incurred growth within the HSA

As long as you can cover some or all of your medical expenses out of pocket, this method could result in earning more of a return on your HSA contributions, which would mean more money in your account that you didn’t have to contribute yourself.

The money you withdraw could be used however you see fit, like supplementing your other retirement funds.

3. After 65, penalty-free withdrawals

If they're made for non-medical expenses, HSA withdrawals are taxed and you can incur a 20% tax penalty on top of it. However, once you turn 65 years old, all withdrawals are penalty-free, even if they’re for a non-medical expense.*

That means you could continue to let leftover HSA funds grow into retirement and withdraw them at a later date. Or, you could withdraw those funds at 65 and delay withdrawing from other retirement funds, like your 401(k) or IRA. That extra source of retirement income can have tremendous value.

4. Employer contributions

Most employers contribute to their employees’ company HSAs. These funds put more tax-advantaged money to work for you. That could add up in a big way when you consider that any growth and withdrawals are tax-free.

What to remember

Healthcare is a major expense in retirement, so having tax-advantaged funds on your side to help soften the blow is key. HSAs can be a valuable asset to any retirement plan, but to have an HSA, you must have what is known as a high deductible healthcare plan (HDHP), which has a lower premium and a higher deductible. Check with your employer to see if you’re eligible for an HSA, since not all HDHPs are HSA-qualified.

If you manage to avoid major healthcare expenses, your HSA funds could be withdrawn tax-free after age 65 to cover other retirement expenses.

More information

Every retirement plan is different. Learn how a Citizens Retirement Checkup® can help you see how you're tracking toward your retirement goals.

* Withdrawals for non-medical expenses are still subject to income tax.

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