Health Savings Accounts (HSAs) are commonly viewed as tools to pay for current medical expenses, but they are increasingly recognized as a tax-advantaged retirement planning vehicle. With triple tax benefits—tax-deductible contributions, tax-deferred growth and tax-free withdrawals for qualified medical expenses—HSAs can function similarly to a retirement account such as an IRA or 401(k). For individuals who can pay current healthcare costs out of pocket, allowing HSA funds to grow over time may significantly enhance long-term wealth accumulation.
Unlike traditional retirement accounts, HSA funds can be used at any age for qualified medical expenses without penalties, including costs often incurred in retirement such as Medicare premiums, long-term care expenses, and out-of-pocket healthcare costs. After age 65, HSA funds can also be withdrawn for non-medical purposes without a penalty, though those withdrawals are subject to ordinary income tax—much like distributions from a traditional IRA. This flexibility makes HSAs a hybrid account that blends healthcare planning with retirement strategy.
However, HSAs have a critical estate planning distinction that is frequently overlooked. Upon an account holder’s death, if the beneficiary is not a surviving spouse, the HSA generally loses its tax-advantaged status. The full fair market value of the account becomes taxable income to the beneficiary in the year of the account holder’s death, creating a significant and unexpected income tax burden, particularly if the HSA has grown substantially over time. As a result, HSAs require careful beneficiary planning and thoughtful coordination with other retirement and estate assets.
An important planning consideration is the interaction between HSAs and medical expense deductions. If HSA funds are not used to pay medical expenses, those expenses may be claimed as itemized deductions on a federal income tax return, subject to the applicable adjusted gross income (AGI) thresholds and limitations. This creates a strategic choice: use tax-free HSA funds now or preserve HSA assets for later while potentially deducting medical expenses. The analysis depends on income levels, tax brackets and future planning goals.
State tax treatment adds another layer of complexity—especially in New Jersey. While HSA contributions are deductible for federal income tax purposes, New Jersey does not allow a state income tax deduction for HSA contributions, nor does it fully conform to federal HSA tax treatment. This means the tax benefits of an HSA are reduced at the state level for New Jersey residents. For high-income taxpayers or those engaged in advanced retirement and estate planning, understanding these federal-versus-state differences is essential to maximizing after-tax outcomes.
Health Savings Accounts can be highly effective tools for long-term wealth accumulation, but their value depends on thoughtful coordination with broader retirement, tax, and estate planning strategies. Contribution decisions, investment growth, beneficiary designations, and state-specific tax treatment all affect whether an HSA enhances or undermines overall planning goals. As HSAs grow in size and importance, periodic review and strategic integration with other assets is essential to avoid unintended tax consequences and to maximize their intended benefits.
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Michael Salad is an attorney in Cooper Levenson’s Business & Tax practice group. He concentrates his practice on estate and asset protection planning, probate and trust administration, special needs planning, business transactions, mergers and acquisitions and tax matters. Michael holds an LL.M. in Estate Planning and Elder Law. Michael is licensed to practice law in Florida, New Jersey, New York, Pennsylvania, Maryland, Connecticut, Georgia, Massachusetts, Alabama, Arizona, Virginia and the District of Columbia. Michael may be reached at (954) 889-1850 or via e-mail at msalad@cooperlevenson.com.
The content of this post should not be construed as legal advice. You should consult a lawyer concerning your particular situation and any specific legal question you may have.