The Three Phases of Health Savings Accounts
A Health Savings Account (HSA) is more than just a savings tool—it’s a smart, tax-advantaged way to help you manage your healthcare costs. Whether you're looking to save for current medical expenses or plan for the future, an HSA can play a key role in your financial strategy. Let's break down the three phases of using an HSA to maximize its potential.
Phase 1: Contributing to Your HSA
When you’re healthy and working, contributing to your HSA can be a smart way to save. Since contributions to an HSA are tax-deductible, and the investment growth is tax-free, these accounts are one of the most efficient ways to save for medical costs — and potentially even for retirement.
Many people find they don’t need to tap into their HSA for medical expenses in their younger years, so it becomes more of a long-term savings vehicle. Tip: If you have medical expenses, it may be best to pay them from your after-tax income, allowing your HSA funds to continue growing tax-free.
The key here is to focus on contributing consistently and growing your HSA over time, alongside your other retirement savings.
Phase 2: Continued Growth After Medicare Enrollment
Once you enroll in Medicare, you can no longer contribute to your HSA. To qualify for HSA contributions, you need to be covered by a qualifying HDHP (high-deductible health plan). Unfortunately, Medicare doesn’t meet this requirement, so once you enroll in Medicare (typically at age 65 or earlier if you opt in), you’ll lose eligibility to contribute to your HSA.
However, even after you stop contributing, your HSA remains a valuable asset. You can still use the funds to cover qualified medical expenses, and the account continues to grow tax-free. Tip: If possible, leave your HSA funds untouched so they can continue to grow, which will provide more funds for medical needs in the future.
Phase 3: Using Your HSA Funds
In the final phase of an HSA, when it’s time to use the funds, you have a few options. Ideally, the funds should be used for qualified medical expenses, allowing them to be withdrawn tax-free. But if the funds are not used and you pass away, there are some important tax implications to consider.
If the HSA is passed to a non-spouse beneficiary, the funds will be taxed as ordinary income in the year of your death. If it goes into your estate, the funds will be included in your final tax return as taxable income. This can result in significant tax liability.
Tip: To avoid these steep taxes, make sure to use the HSA funds for qualified medical expenses before your passing or transfer the account to a spouse. The spouse can then treat it as their own HSA, continuing to benefit from the tax-free growth and withdrawals for qualified medical expenses.
Final Thoughts
HSAs are versatile financial tools that can help you save on medical costs now and in the future. Whether you're contributing to your account, letting it grow, or using it in retirement, HSAs remain an excellent way to manage healthcare expenses while taking advantage of tax benefits.
Have questions about setting up an HSA, or how to best utilize one you already have? Feel free to give us a call or set up a meeting. We’re here to help!
