Is it Possible to Save Too Much in a Health Savings Account?

Is it Possible to Save Too Much in a Health Savings Account?

October 27, 2023

The short answer: probably not!

Balances in Health Savings Accounts (HSA) have grown considerably since their introduction 20 years ago.  HSA consultant Devenir reported assets of over $100 billion in HSAs at the end of 2022.  About two-thirds of total HSA assets are parked in savings accounts, however, rather than invested for long-term growth potential and/or future health expenses in retirement.

There’s no question that many HSA participants are funding their accounts primarily for the upfront tax deduction, but also for tax-free withdrawals to cover current healthcare expenses, and this may be the best alternative for their circumstances.  There are, however, many HSA participants who are attracted to the current and future tax benefits of funding an HSA and leaving the account alone to grow for years or, in some cases, decades.  Considering contributions are funded on a pretax basis (even pre-payroll taxes if funded via payroll deduction), enjoy tax-free compounding and allow for tax-free withdrawals for qualified expenses, many consider the HSA to be an even more powerful retirement savings vehicle than a 401(k) or IRA.

So, is it possible to contribute more to an HSA than you’re likely to spend on healthcare costs?  Fortunately, HSAs have pretty generous withdrawal features including ways to access your funds without negating the tax benefits of the account.

One of the best features is the ability to reimburse yourself for prior out-of-pocket healthcare expenses.  If you’re using your HSA primarily as a tax-free investment vehicle, and therefore using non-HSA savings or cash flows to cover medical costs, be sure to save your receipts for those out-of-pocket expenses.  There is no time limit on when reimbursements can be made for prior health expenses, so tax-free withdrawals can be made in the future as long as you have proper documentation for the prior expenses.  Best of all, you can spend the reimbursed funds on whatever you like.  So, if you need funds to replace a vehicle or make a home repair, you could access funds from your HSA tax-free as long as you have receipts for qualified healthcare expenses equal to or less than the total amount of your withdrawal (that haven’t previously been reimbursed).

Another feature is that withdrawals can be made for any reason after the owner attains age 65.  If the withdrawal is for a non-healthcare expense, it would be taxed as ordinary income, just like a withdrawal from a 401(k) or IRA.  It should be noted that non-healthcare withdrawals after age 65 could still be tax-free as a reimbursement, provided you have documentation for prior qualified healthcare expenses.

As you can see, the tax benefits for current participants are quite generous, but that generosity doesn’t extend as far after death.  While spousal beneficiaries can maintain the account as an HSA, with all the attendant tax benefits, non-spouse beneficiaries will be taxed on any remaining balance they inherit.  Therefore, HSA owners with a non-spouse beneficiary, or a spousal beneficiary who has a similar or limited life expectancy compared to the owner, should consider prioritizing HSA withdrawals or naming a charity as beneficiary (the charity would receive the balance tax-free).

HSAs are not right in all circumstances, partly because in order to fund an HSA, you need to be covered under a high-deductible health plan which may not always be the best alternative.  But for those able to fund an HSA and use non-HSA funds to cover current health expenses, it’s clear that maximizing HSA contributions provides considerable tax-benefits and future cash flow flexibility and should be prioritized as part of an overall retirement savings strategy.




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