health savings accounts

High-income earners who’ve maxed out their retirement accounts are following a lucrative strategy to boost returns from their Health Savings Accounts (HSA). The trick is to treat an HSA as another retirement account, like an IRA or 401(k) plan, and forgo withdrawals until retirement.

In practical terms, when you do incur medical expenses you pay them out of pocket without touching your HSA tax shelter. The result is, each $1,000 in medical bills you pay out of pocket leaves $1,000 in your HSA to invest and grow tax-free until retirement. You can then withdraw that $1,000, plus all that it has earned as an investment over the years, tax-free!

Eligibility for HSA plans

You are only eligible to contribute to an HSA if your sole health insurance is a qualified high deductible health plan. But you can continue to use and withdraw from the HSA once you are no longer eligible to contribute. Unlike most health insurance, the high deductible health plan pays nothing except for preventive care until you meet a relatively high deductible. The plan may make its own contribution to the HSA in order to reduce your potential out of pocket costs.

IRS contribution limits for HSA 2017

HSA contribution limit (employer + employee)Self-only: $3,400
Family: $6,750
HSA catch-up contributions (age 55 or older)*$1,000
HDHP minimum deductiblesSelf-only: $1,300
Family: $2,600
HDHP maximum out-of-pocket amounts (deductibles, co-payments and other amounts, but not premiums)Self-only: $6,550
Family: $13,100

How the account operates

The HSA custodian is a bank, and the account initially works like a bank account — you can make deposits, and withdraw money with checks or a debit card. Once you have enough money in the account, the bank allows you to link the account to a mutual fund or brokerage account. You still write checks against the bank account and must transfer money to the bank account in order to use it.

You can choose your custodian, and transfer accounts between different custodians. However, if your health plan or employer makes a contribution, it may select the custodian to which it makes contributions, and may offer other incentives such as waiving service fees.

HSA tax considerations

Unlike many other tax deductions, there are no income restrictions to contribute to an HSA. Contributions to an HSA reduce your federal adjusted gross income dollar for dollar, possibly making you eligible for income-based credits or Roth IRA contributions you would not otherwise be eligible for without the HSA deduction.

Contributions are deductible on your federal income tax, but not always on state income tax. The states of Alabama, California and New Jersey do not follow federal legislation and do not recognize HSAs, so contributions are not deductible and earnings are taxable. If you live in a state which taxes HSA earnings, consider investing in instruments which are exempt from state taxes.

Withdrawals from HSAs

Withdrawals for qualified medical expenses are tax-free. As long as you keep proper records, you can even reimburse yourself in a later year for medical expenses which you paid out of pocket.

Withdrawals for other purposes are taxed at your full tax rate, with an extra 20 percent penalty. The penalty is waived if you are at least 65 or disabled, and if you die and do not leave the account to a spouse, the account is distributed with tax but with no penalty.


You can make a once in a lifetime rollover or transfer from an IRA to an HSA up to the annual HSA funding limit. This is usually not advised since you would lose the ability to contribute and take an HSA tax deduction for the amount you transfer, but it can be an emergency source of funds without paying taxes or penalties.

If you contribute to a general-purpose Flexible Spending Account (FSA), often called a health, health care or medical FSA, you may not contribute to an HSA even if you have an otherwise-qualifying high deductible health plan. But you may contribute to both a HSA and a limited-purpose FSA. Money in an FSA is lost if not used within a specified period, however, so you can only use it for expected expenses. Unexpected medical expenses you pay with after-tax dollars.

Paying current expenses from the HSA

If you are not maxing out your retirement accounts, you generally should pay current expenses from the HSA. If you are in a 25 percent tax bracket and have $1,000 in medical bills, taking $1,000 from the HSA, and taking advantage of the fact that this wasn’t an out of pocket expense so that you can invest an extra $1,000 in your Roth IRA or $1,333 in your 401(k), works to your benefit.

If you kept the $1,000 in the HSA and paid the expense out of pocket, you would have the right to withdraw $1,000 from the HSA later to cover the expense and spend $1,000 on anything later. But if you invested the $1,000 in a Roth IRA, you gained the right to spend not only that $1,000 on anything in retirement, but also the gains on that $1,000; if you invested $1,333 in a 401(k), that is just as good after adjusting for the 25 percent tax you will pay in retirement.

HSAs can be used to pay Medicare premiums and other medical expenses in retirement. If you are too healthy in retirement and can’t use the HSA for medical expenses (even past ones), the non-medical portion is still as good as a traditional IRA once you are age 65.

Your HSA legacy

You have the option to leave your HSA to your spouse who could roll your HSA into their HSA account, treating the funds as if they’d always been there and using them tax-free for their medical expenses.

The rules are different if you choose a beneficiary other than a spouse. If you die with an HSA balance remaining, the tax on the entire balance becomes due and payable in the first year after your death. Your beneficiary does have the option to use funds in the account to pay your medical expenses within one year of your death. And your beneficiary is not eligible to use remaining balances in your HSA to pay their own medical expenses. Nor is your beneficiary eligible to collect payment for your past out of pocket expenses since your beneficiary didn’t pay for them, you did.

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