HSAs: An Overlooked Retirement Savings Vehicle

When it comes to big expenses in retirement, there’s the fun stuff: membership in a golf club, bucket-list vacations and spoiling your grandchildren. But for many retirees, the single biggest expense is less exciting to plan for: health-care costs.

An average retired couple, both age 65, may need approximately $315,000 in after-tax savings to cover health-care expenses in retirement.¹ As people live longer and health-care cost inflation continues to outpace general inflation, it’s more important than ever to prepare for such expenses and to protect your financial security through your golden years. 

For many, that upfront planning includes the use of a health savings account (HSA), an often-misunderstood savings vehicle offered in certain employer-sponsored health insurance plans. HSAs can be a good savings vehicle, but they can also be confusing, and even savers who use an HSA may not be getting all their potential benefits.

Here’s what you need to know:

What is an HSA?

HSAs are savings vehicles that offer a triple tax advantage:

1. Contributions go into the HSA tax-free If you make contributions through payroll deductions, they are also not subject to Social Security or Medicare taxes.
2. You can invest that money and enjoy tax-free growth potential.
3. Withdrawals for qualified health expenses don’t incur taxes.

Under IRS rules, you can open and contribute to an HSA only if you are enrolled in a high-deductible health plan. In recent years, more employers have begun to offer high-deductible plans, with about a third employers that have health benefits now offering this type of plan to their workers.² These health plans tend to have relatively low premiums and higher out-of-pocket expenses, which the HSA may help offset.

“People often see the high deductible and get scared away, but it’s worth a conversation with your Financial Advisor about the financial benefits that the HSA can offer,” says Dana Erdfarb, Executive Director, HR Benefits Planning and Management at Morgan Stanley.

An Extra Retirement Account

If you’re already maxing out your 401(k) contributions, your HSA can serve as another place for you to save for retirement. While developed as a way to help people manage the cost of high health insurance deductibles, they also provide an opportunity for long-term savings.

Unlike money in a flexible spending account (FSA), HSA funds remain in your account from year-to-year if you don’t spend them, and you even retain ownership of the account if you leave your job or switch health plans. That means any investment earnings in your HSA have the potential to grow for decades, effectively creating an extra tax-advantaged retirement fund—in addition to your 401(k) and any IRAs—that you can earmark for health-care expenses later in life. Keep in mind, though, that if you switch from a high deductible health plan to another type of health plan, you will not be able to contribute further to the HSA until you are once again covered by a high-deductible health plan. You can, however, still use it to pay for qualified expenses.

For the 2024 tax year, you have until Tax Day 2025 to contribute to an HSA account—up to $4,150 for individuals and $8,300 for families,³ while individuals age 55 or older can save an additional $1,000 per year in “catch-up contributions” to an HSA.⁴

You may also get some help from your employer. In 2023, employers contributing to employee has accounts gave, on average, $726.⁵ Please note Morgan Stanley does not seed HSAs.

Paying for Medical Costs Along the Way

If you use after-tax dollars to pay for big-ticket health expenses now, you can also save your receipts to give yourself a windfall via a tax-free HSA reimbursement years or decades later—even if you choose to use the money prior to retirement.

“You have the flexibility to submit claims for qualified health-care expenses that you’ve already paid out-of-pocket since establishing your HSA and get reimbursed whenever you want,” says Jennifer Cacciatore, Executive Director, HR Retirement & Investments, for Morgan Stanley. In addition to medical expenses, HSAs can cover dental and vision costs.

While you aren’t allowed to contribute  to an HSA once you’ve enrolled in Medicare, these accounts offer new benefits in retirement. In addition to using your HSA for qualified medical expenses, after age 65 you can use it for non-medical expenses without penalty, though you’ll have to pay taxes on those withdrawals.⁶ (If you use it for non-qualified expenses before age 65, you’ll owe taxes and a 20% penalty.) And, unlike 401(k) plans and traditional IRAs, HSAs don’t have minimum required distributions, so you can keep your money in the HSA until you’re ready to use it. 

Consider the Bigger Financial Picture

Most HSA providers allow account holders to invest their holdings once they reach a certain balance. Just as you have a limited set of investment options to choose from in most 401(k)s, your HSA provider typically offers a predetermined list of investments.

If you aren’t satisfied with the investment options or fees in the HSA offered through work, or if your employer doesn’t offer an HSA, you can shop around and put money into an outside HSA plan. Keep in mind, though, that going with a different HSA account means your employer won’t automatically deposit the money tax-free on your behalf or pay any administrative fees for maintaining the account, and your contribution will be subject to Social Security and Medicare tax. You’ll have to fund the HSA with after-tax dollars throughout the year and then reconcile it on your tax return at the end of the year.

Of course, your HSA is just one piece of a bigger picture when it comes to your financial life. Decisions about whether to put money into an HSA, how much to save and when to use that money, should all fit into that bigger picture. Talk with your Morgan Stanley Financial Advisor today about how you can save for an optimal retirement and cover health-care costs later in life.