Do I need a Health Savings Account? Here's the real truth about HSAs and whether (or not) they make smart retirement vehicles

HSAs: The benefits

With HDHPs, unexpected medical events like breaking an arm or undergoing an urgent surgery usually aren’t covered and need to be paid for out of pocket. That’s where an HSA comes in handy, because those funds can be used to cover costs a person’s HDHP wouldn’t.

Consider also that withdrawals from HSA accounts — which hold your pre-tax and tax-deductible earnings — are tax-free when used for medical expenses. That’s almost like a tax discount from Uncle Sam.

Another advantage of having an HSA is flexibility. Those with HSAs can use account funds to pay for a wide range of medical expenses, including everything from deductibles and copayments to prescriptions. It’s up to each individual to manage their HSA account, but that also means they’re free to decide how to spend their health care dollars — whether that be on alternative treatments or the very bare necessities, it’s a matter of personal choice.

Additionally, HSA money rolls over year to year, meaning one can use their account as a sort of health care nest egg.

Plus, many plans now allow HSA participants to invest their contributions in the market.

So what’s not to love? Plenty actually.

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HSAs: The fine print

Let’s start with the relatively paltry annual contribution limits. For 2023, the maximum an individual can contribute is $3,850, and for a family that goes up to $7,750. For the relatively healthy, that may be plenty. But for Americans with chronic illnesses who require frequent treatments, surgeries or prescriptions, these limits could be restrictive.

HSAs also require a bit of proactive management, which can be tricky for those with poor money-management skills, or even for those dealing with a range of health conditions. Not to mention if you choose to invest your HSA funds in the market, you risk potential losses.

It’s also important to remember that while HSA withdrawals are only tax-free when they’re used for qualified medical expenses. If you try to withdraw funds for any non-medical expenses before the age of 65, you’ll face a 20% penalty, in addition to income taxes. After 65, non-medical withdrawals are subject to income taxes, but not the penalty.

There’s an additional bittersweet risk: If you regularly contribute to an HSA and end up not being able to use all your money, congratulations on your good health! But the downside is of course you’ll end up with a large and perhaps unusable HSA balance.

And on the other hand, if you rack up significant health care expenses in retirement, you could quickly exhaust your HSA balance and be left with insufficient funds for other retirement expenses.

So before rushing to sign up for an HSA, it’s important to weigh things like your personal health situation and retirement plans against the unique benefits and potential risks of the health savings account.