Tax planning has always been a cornerstone of real, comprehensive financial planning. However, over the past couple years, there has been a noticeable uptick in attention given to the topic. Whether it's professionals sharing ideas on LinkedIn or TikTok influencers promoting tax hacks, the space has become increasingly crowded with voices offering strategies that promise to immediately improve your tax situation. Not always, but often their methods push the boundaries of the law, and many are simply too good to be true.
The reality is that effective tax planning is rarely flashy. Aside from a handful of us, most people find it pretty boring. Seldom is there an exciting, standalone solution that will dramatically improve your tax liability in any given year. Instead, impactful tax planning is often the result of many small strategies working together. Individually, they may be insignificant. But when implemented collectively, and repeated year after year, they can meaningfully reduce the total taxes you pay over your lifetime.
One of those strategies is the use of Health Savings Accounts (HSAs). More specifically, it involves delaying reimbursement for qualified medical expenses and allowing your HSA funds to remain invested. Done correctly, this can effectively turn your HSA into another retirement account.
How does an HSA work?
The Basics
An HSA is a tax-advantaged account designed to help individuals pay for qualified medical expenses, including copays, prescriptions, medical care, preventive care, and some insurance premiums (more on this later). Here’s how they work:
1. Contributions are federally tax-deductible
HSA contributions are an above-the-line income tax deduction, and a simple way to reduce your tax liability. See table below:
Like a retirement account, contributions can be made by the account holder, their employer, or a combination of the two. Employer contributions count toward the account holder's annual contribution limit.
Notably, unlike retirement accounts, earned income is not required to make HSA contributions, creating a tax planning opportunity for individuals who retire before Medicare eligibility at age 65.
2. Investment growth/earnings are federally tax-deferred
Like a retirement account, while funds remain inside an HSA, the investment income (interest, dividends and capital gains) is federally tax deferred.
3. Qualified withdrawals are tax-free
Withdrawals at any time used to pay or reimburse yourself for qualified medical expenses are tax-free.
Funds withdrawn for non-qualified medical expenses before age 65 are subject to ordinary federal income tax and a 20% penalty.
After age 65, non-qualified withdrawals remain taxable as ordinary federal income but are no longer subject to the 20% penalty. At that point, HSAs function similarly to a pre-tax retirement account, with the added benefit that qualified medical expenses can still be withdrawn tax-free.
“Triple Tax Advantaged”
HSAs are frequently referred to as “triple tax advantaged” because, unlike pre-tax or Roth retirement accounts, they offer a federal tax benefit at all three levels: tax-deductible contributions, tax-free growth, tax-free withdrawals. See table below:
California and New Jersey Residents
Believe it or not, California and New Jersey do not conform to the federal treatment of HSAs. Meaning:
- Employee and employer contributions are not state tax-deductible, therefore must be added back to your state income when filing taxes.
- Investment earnings are not tax-deferred. So, any interest, dividends, or capital gains realized in the account during the calendar year should be tracked and added back to your state income when filing taxes.
- Withdrawals are effectively tax-neutral since you never received a state income tax deduction at the time of the contribution, and the investment earnings were not tax-deferred. Also, withdrawals for non-qualified medical expenses are not subject to a penalty in this case.
California and New Jersey essentially view HSAs as taxable brokerage accounts rather than tax-advantaged accounts like on the federal level.
HSA Eligibility
To contribute to an HSA, you must be enrolled in a High-Deductible Health Plan (HDHP). These plans typically offer lower monthly premiums in exchange for higher deductibles and out-of-pocket maximums, both of which are adjusted annually for inflation. See table below:
While the IRS establishes minimum deductible requirements for HDHPs, the reality is that most plans have significantly higher deductibles than the thresholds listed above.
For individuals who are generally healthy and don't expect substantial medical expenses, the premium savings from a HDHP can be real. Conversely, if you do incur significant medical expenses while enrolled in a HDHP, the savings from lower premiums could be eroded by the higher out-of-pocket costs, since coinsurance doesn’t generally begin until you’ve satisfied the plan’s deductible.
Notably, your HSA doesn’t close if you switch from a HDHP to a low-deductible plan. The account remains open and you can continue directing the investments. You just can’t continue making contributions while not being covered by a HDHP.
How can I turn my HSA into a retirement account?
The core of the strategy has to do with the concept of compound interest/growth.
Since the IRS allows reimbursements to be deferred indefinitely, an alternative to swiping your HSA debit card or reimbursing yourself immediately for qualified medical expenses, is to pay for these expenses out-of-pocket instead, cash flow permitting.
By doing so, you allow your HSA funds to remain invested and continue compounding uninterrupted. Over time, investment growth, along with consistent annual contributions, can produce a useful asset for retirement.
For example, assume an individual contributes $4,400 annually to their HSA and earns an average return of 7% per year. After 25 years, the account would be worth nearly $300,000.
But what about all the reimbursements that were deferred along the way? They effectively create a basis in the account, which can be withdrawn at any time, for any reason, tax-free.
Let's assume that during those same 25 years, the individual above incurred and paid $2,000 of qualified medical expenses out-of-pocket annually. They would have accumulated $50,000 of eligible reimbursements that could be withdrawn from the account completely tax-free.
This can be particularly valuable for individuals near or in retirement, who are trying to strategically manage their taxable income for purposes such as Affordable Care Act health insurance subsidies, Medicare monthly surcharges, and/or the taxability of Social Security benefits.
To implement this strategy properly, you must be very organized and meticulously track your qualified medical expense receipts to substantiate tax-free distributions in case of an IRS audit. Rather than storing paper copies in your desk drawer, consider taking a picture of or scanning the receipt and saving the file to a digital folder. Several of our clients have dedicated a folder in their Client Vault to qualified medical expense receipts.
The last piece of the puzzle is selecting the right HSA provider. While individuals receiving employer contributions or making payroll-deducted contributions will likely have less flexibility, those looking to open a retail HSA should be familiar with the available providers in the marketplace. Excessive fees, poor investment options, and negligible interest on cash balances can diminish the long-term benefits of delaying reimbursements.
Although we don’t endorse a specific provider, Fidelity has consistently scored near the top of Morningstar’s annual HSA assessment.1 See below:
One Drawback
Unlike taxable brokerage accounts, which generally receive a step-up in basis at death, or retirement accounts, which are often distributed over a ten-year period by non-spouse beneficiaries, HSAs become fully taxable in the year inherited by a non-spouse.
Due to this, it’s not a stretch to say that an HSA is one of the least tax-efficient assets to leave to non-spouse beneficiaries. So, if you do end up deferring your reimbursements, it’s prudent to prioritize spending down your HSA before other accounts once near or in retirement.
First, you can reimburse yourself for qualified medical expenses incurred years earlier.
Second, you can use the account for ongoing and future qualified medical expenses, including premiums for COBRA, Medicare, and Long-Term Care insurance. A recent Fidelity article estimated that a 65-year-old retiring in 2026 can expect to spend on average $185,500 ($371,000 for married couples) on health care throughout retirement.2 Given that estimate, most retirees won’t be short of opportunities to use their HSA balance.
Then, after age 65, you can just treat the account like your other pre-tax retirement accounts and take distributions when needed. Knowing that withdrawals for non-qualified expenses will be subject to ordinary federal income taxes, but not the 20% penalty.
As a last resort, if you’re philanthropic, you could name a charitable organization as your primary beneficiary and leave other assets that receive more favorable tax treatment during the estate administration process for your family.
Bottom Line
Delaying reimbursements and building another tax-advantaged retirement account may sound appealing, but don’t switch to a HDHP solely to pursue this strategy. You and your family’s healthcare needs should be considered first. If you anticipate high medical expenses, the savings from lower monthly premiums and the benefits of deferring reimbursements could be completely offset by the higher out of pocket costs associated with HDHPs.
It's perfectly fine to reimburse yourself immediately for medical expenses. After all, that's exactly what HSAs are designed to do. If you never implement this strategy, but your savings habits are otherwise strong, it's not going to derail the success of your retirement plan. Conversely, this strategy alone isn't going to rescue a retirement plan that is otherwise falling short. This is one tool in a much larger financial and tax planning toolkit.
That said, for those with strong cash flow, delaying reimbursements can create a legitimate source of tax-free income in retirement. Just remember that HSAs are among the least tax-efficient assets to leave to non-spouse beneficiaries. If you implement this strategy, you should also have a plan to intentionally draw down the account.
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