Using an HSA: Tax Deduction Now, Tax-Free Money Later for Medical Expenses

By on December 18, 2012 in Current Events, Retirement with 17 Comments

HSAs (Health Savings Accounts) are special accounts designed to give you a tax deduction for qualified medical expenses.

If you qualify for an HSA, you decide how much money you want to contribute (up to a the limit) – and you decide when you use the money. If done correctly, you get a tax deduction for the money you put in now – and if you take the money out for qualified medical expenses, the money comes out tax-free.

Many people who use HSAs take money out now for their current medical expenses. And this can still be beneficial to your taxes. But why not go the extra mile?

It’s pretty safe to say that at some point in retirement – you’ll have to pay for medical expenses out of pocket. Why not save for it and get the tax advantage?

So if you’re in good financial shape, consider funding your HSA each year you can to get the tax deduction.

Then in the years leading up to retirement, when you do have medical expenses, pay for those out of pocket and leave your HSA to grow. When you take it out for qualified medical expenses your contributions and interest come out tax-free.

Who Can Have an HSA?

There are special rules for HSAs, and they’re not ideal for everyone. In order to qualify for an HSA, you must…

  • Have a High-Deductible Health Plan (HDHP)
  • You can’t be covered by any other insurance plan that’s not HDHP
  • You can’t be claimed as a dependent on anyone else’s tax return
  • You can’t be on Medicare.

The IRS has a special publication about HSAs, Pub 969 Health Savings Accounts and Other Tax-Favored Health Plans.

How Much Can You Contribute to an HSA?

In 2012, the amount of money you can put into an HSA is $3,100 for an individual, or $6,250 for a family. And you can put in an additional catch-up provision of $1,000 if you’re over age 55. If both you and your spouse are over age 55, that means your family limit could be as high as $8,250 a year.

Limited Window to Fund HSA

One of the qualifications to fund an HSA is that you are not on Medicare. Since most federal retirees will start Medicare at age 65 – this means the ‘window’ to fund your HSA is limited.

For example, say you’re 55 now and you’ll be going on Medicare at 65. If you qualify for an HSA (and continue to qualify each year) – that only leaves you with 10 years to fund your HSA. But if you’re 62 now, you might only have 3 years to be funding your HSA.

You can still use the money in your HSA account after you go on Medicare – but you’ll no longer be able to put more money into your HSA and receive a tax deduction. So the window to fund your HSA is limited.

HSAs are Not For Everyone

HSAs are not right for everyone. Let’s take a closer look at some things to think about if you’re considering an HSA…

#1) Must Be a Good Fit for HDHP

In order to have an HSA, you must have a High-Deductible Health Plan. So before you consider an HSA, you need to make sure that having a HDHP is good for you. If you’re not comfortable with an HDHP, then an HSA is not right for you.

If you’re in good health, and you rarely hit your deductible, you might be a good candidate for a high-deductible plan. In general, the higher your deductible, the lower your premium costs – so moving to a high-deductible plan might save you money. But only if you are in good health and don’t have a lot of medical expenses.

If you hit your deductible every year, or have a lot of medical expenses – it probably doesn’t make sense to do a high-deductible plan.

OPM has a page of helpful links about the HDHP plans and how they work with HSAs.

#2) Must Be Comfortable with Responsibility of HSA

There is not a lot of oversight with an HSA when you compare it to other plans like FSAs. You can take money out of your HSA to pay for qualified medical expenses – but you are the one responsible for making sure the expenses you have are qualified or not.

No one will stop you from taking money out of your HSA for something that’s not qualified – but you’ll be hit with taxes and penalty when it’s found by the IRS.

#3) Must Understand Additional Tax Requirements

With an HSA, you are responsible for reporting some additional information on your tax return each year. For example, you’ll need to report how much money you contributed, how much money you took out (if any), and how much of that was for qualified medical expenses.

You must also keep good records showing your medical expenses were qualified. While you don’t submit these with your taxes – you are to keep them with your own personal tax records in case the IRS has questions in the future.

Extra Consideration for the Long-Term Play: Must Be in Good Financial Shape

Using an HSA to pay for medical expenses in retirement means that you need to have the cash to fund your HSA now, and the ability to wait for years (possibly even decades) to use it.

So in order to make this work – you need to be in good shape financially to be able to save the money and still pay for your expenses out of cash-flow now.

This idea gets the most bang for your buck when you can let that money ride and be a bit of a safety net 20 years from now.

HSA: Tax Deduction Now, Tax-Free Money Later for Medical Expenses

When you use this right – you get a tax deduction now, and get to use the money tax-free for qualified medical expenses (that you were probably already going to have to pay for anyways).

But this way, instead of having to pay for those medical expenses on dollars that were taxed – you can get a tax benefit.

This is a more advanced planning technique best suited for people who are doing well and who already have their financial ducks in a row.

Using an HSA to save for medical expenses in retirement is a long term play. But if you’re in good health and in good financial shape – you might be able to take advantage of the benefits of using an HSA this way.

Interested in Learning More?

I’ve taken my experience as a pre-retirement class teacher and as a financial planner for federal employees and created an online do-it-yourself program called FERS Route to Retirement.  HSAs are just one of the topics covered in my online program called FERS Route to Retirement.

See a full list of topics we cover in FERS Route to Retirement

© 2016 Micah Shilanski, CFP®. All rights reserved. This article may not be reproduced without express written consent from Micah Shilanski, CFP®.


About the Author

Micah Shilanski is a Certified Financial Planner™ professional who specializes in helping federal employees get the most out of their retirement benefits. Micah helps his clients with tax planning, retirement planning, federal retirement planning, estate planning, and investment advice.

Plan Your Federal Retirement is a dba of Shilanski & Associates, Inc., an Alaska Registered Investment Advisor, with securities offered through Summit Brokerage Services, Inc., Member FINRA/SIPC.

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  1. PS says:

    We thought we’d do the “long term play” discussed here.  But that doesn’t work because the bank that holds the HSA (a) pays virtually no interest on the account and (b) charges fees for everything, including “inactivity” (making few claims) and moving the account to any other bank.  So it’s lose-lose in my experience.  The employer’s HDHP is no longer offered, so we can’t keep the account active by contributing more, only by withdrawing.  When I did try to use the Bancorp-issued debit card to pay a doctor, I found Bancorp had cancelled the card because I hadn’t used it for awhile, and then they wanted to charge a fee to send a new card!  They routinely unilaterally raise fees and the account holder has no leverage with them at all.
    Moral of the story:  don’t accept the bank your HSA is assigned to — move it immediately to a bank that you trust (if there is such a thing).  Or, better yet,  just don’t get involved with it to begin with.  I wish I hadn’t.

  2. Smogdung says:

    I just called Mailhandlers……your spouse can only contribute an extra $1K if they have their own HSA.  So, if the HSA you have is a Family Plan……& you/both are over 55……it’s just $1K extra not $2K…..unless you create a separate plan for your spouse.    But the biggy is that at 65 you can start reimbursing yourself for you insurance premiums from your account…..even if you drop FEHB plan and start paying for the extra medicare premiums.  TAX FREE.

  3. Smogdung says:

    I don’t believe a married family plan over 55 can put in $2K extra….only $!K extra.   The big benefit the author didn’t mention is that once you hit 65……it’s legal to pay (reimburse yourself) for your health insurance premiums from your account!!!!!. 

  4. Holly says:

    I normally contribute $2,000 to FSA and use it up 3/4 through the year between mine and hubby’s prescriptions, yearly checkups, twice yearly cleanings, it adds up. This year I maxed at $2500. because I have already been told I need a crown (I’m holding off until January). I don’t carry the dental insurance because I normally just need cleanings and the insurance is expensive.

  5. Old Fed says:

    I have a healthcare FSA (Flexible Spending Account). I am a current Federal employee. We can only fund $2500 per year and it has to all be used or you lose it. There is a difference between the FSA and the HSA. I don’t want to pay the high deductible required by HDHP’s, but a FSA is perfect for me. Great to have if you are having a lot of dental work done. Even with a good dental plan, they typically only cover half for things like crowns. The FSA takes care of the rest of it, as long as you put enough money in.

    • grannybunny says:

      Agreed, I use the heck out of my FSA.  At the very beginning of the year — even before you’ve put anything in — you can spend the whole amount and get reimbursed, should you have a large out-of-pocket expense.  I have direct deposit, and — generally — get reimbursed very quickly, long before the credit card bill is due, if I’ve charged it.

      • ReaperComing says:

        wowo granny is it with a civilian Ins company or FEHB plan ?

      • TheRealOldFed says:

        I also use the “paperless reimbursement” option for the FSA for both my health insurance (Blue Cross Basic) and dental (GEHA High). It’s a really fast way to get reimbursed for the charges, and as you said, generally before you even get a bill from the dentist/doctor. Only problem I’ve had is if I had the same procedure on 2 different teeth on the same day; i.e., 2 crowns. Then I get a reject notice from FSA saying it’s a duplicate charge.  Then, I have to FAX in something from the dentist showing it’s 2 different teeth. But, not a big deal. Works great. I particularly like having access to all of the money you have allocated for the entire year available the first pay period. Since you can’t cancel FSA deductions until the next open season, they know they will get their money.

    • ReaperComing says:

      you are correct i am confusing them sorry, i dont like the 2500 if you cant or dont use it that year, that it cannot be rolled into next year which may have higher expenses, or pay it to you as salary and tax it as an option. It just goes to the tooth fairy. LOL

      • grannybunny says:

        I know what you mean, but — a lot of years – I’ve definitely had to cram alot of spending into the January 1 – March 15th grace period, in order to make sure I didn’t lose anything.  You can stock up on first aid items (but not OTC drugs, without a prescription), contact lens solution, etc., too, if necessary!  🙂

  6. ReaperComing says:

    For a person that can dedicate their time to tracking expenses filing claims it is a good thing. This is an adminisrative nightmare they reject every thing you claim as a medical expense, multiple times some allow over the counter meds some do not, have to be a lawyer to figure it out no care over if any money left you lose it, just simply a headache!! but the tylenol is paid with tax free money (in theroy) Ps government wants this gone away with Obamacare

    • grannybunny says:

      I think you’re confusing this with Flexible Spending Accounts, as I don’t believe that there is a use-it-or-lose-it problem with Health Spending Accounts.

  7. canada bound says:

    give me a break
    more articles for the poor
    do not believe anything anymore
    dim and dimmer or dumb and dumber may fall for this