A health savings account (HSA) can be a tax-advantaged way to save for qualified medical expenses. While HSAs play an important role in financial planning, are they worth using in retirement?

In this week’s Money Wisdom Question Series, Ian Fergusson, RICP® explains the tax benefits of HSAs and when to consider enrolling.

Why Consider an HSA?

Only individuals enrolled in a high-deductible health plan (HDHP) can contribute to an HSA. Enrolling in Medicare or accepting coverage from your spouse’s non-eligible health plan disqualifies you from contributing. So, why have HSAs become increasingly popular savings accounts? Much of their appeal comes from three unique tax advantages.

First, contributions are tax-deductible, up to the annual contribution limits. Second, the funds in the account can grow tax-free. And third, withdrawals used for qualified medical expenses are also tax-free. Qualified expenses include co-pays, prescriptions, eyeglasses, dental care, and more.

Are You Still Eligible for an HSA?

Whether an HSA makes sense for you in retirement depends on your personal situation. If you already have an HSA but are no longer working, are over age 65, and enrolled in Medicare, you can no longer contribute.

However, if you’re still working at 65 but not fully enrolled in Medicare, you may still be eligible. In that case, it’s definitely an option worth considering.

When Should You Use HSAs in Retirement?

Once you’re over 65 and retired, you can use the money in your HSA tax-free for a variety of medical costs. However, if you withdraw HSA funds for something other than a qualified medical expense, there are tax consequences.

The IRS taxes non-qualified withdrawals as ordinary income and charges a 20% penalty before age 65. After age 65, the IRS still taxes the withdrawals as ordinary income but without applying the additional penalty.