By Michelle Masson

Investing in your Health Savings Account, or HSA, is a nearly completely tax-free retirement plan and should be a “no-brainer” for savvy savers: you can contribute to the account tax-free (up to a maximum annual amount), the funds earn tax-free compound gains, and if you take withdrawals for qualified healthcare expenses those withdrawals are tax-free.  You can have your HSA funds put in a savings account or invested in the stock market or long-term securities.  One report showed that HSA investments increased 32% from June 2019 to June 20201.  And all of that increase is non-taxable!

There are things to watch out for with HSAs, though, and ways to avoid these pitfalls:
At any age, you can make tax-free withdrawals ONLY to pay for qualified healthcare expenses.  If you are under age 65, any healthcare costs that you paid for out of pocket after starting your HSA can be reimbursed to you out of your HSA funds, and that withdrawal is tax-free.
For example, Mary has been contributing to her HSA and letting it grow since 2015.  In 2017 she incurred $5,000 of medical expenses, and paid those costs out of her checking account because her HSA is getting much better growth rates than her bank account.  But in 2020 Mary was furloughed for 2 months and needed some extra money to pay her mortgage, car loan, etc.  Mary can withdraw $5,000 from her HSA in 2020, and as long as she kept documentation of her out-of-pocket healthcare costs from 2017, this withdrawal is tax-free.  Then Mary can spend that $5,000 reimbursement on whatever she wants.
After age 65, if you need to withdraw funds and you don’t have qualified healthcare expenses to reimburse, your withdrawals are taxed like an IRA or 401(k) withdrawal.

HSAs do not have the flexibility of other retirement options after the HSA owner’s death.  If your HSA beneficiary is your surviving spouse, the account can continue with all of the HSA benefits.  However, if your beneficiary is another individual, the tax-free status ends and the entire inherited amount is taxable.  Be sure to spend or withdraw your HSA funds, or consider leaving your HSA funds to a charity as they will not owe taxes on the donation.

 1 2020 Midyear Devenir HSA Research Report, released 9/1/2020 by Devenir Research (