Health Savings Accounts (HSAs) are the only accounts that allow you to take a tax deduction, pay no taxes on earnings, and access your money at any time without worrying about taxes or penalties, as long as it's for a qualified medical expense. It's the trifecta. Healthcare expenses are inevitable at some point, so having an HSA lets you put away money you'd be spending anyways and get a tax break while doing it.
Since the money in your HSA can be invested, there's a chance it can experience some pretty good growth (or that's the goal at least), leading some people to wonder if they can become HSA millionaires. As with investing in general, the two things someone needs to reach millionaire status are time and consistency. Let's imagine someone with a family healthcare plan contributed $600 to an HSA -- which is below the annual limit for 2022 -- for 30 years, averaging 10% yearly returns. At the end of those 30 years, they would've accumulated over $1.18 million.
While it feels weird criticizing $1 million because that's a wonderful accomplishment, having that much money in your HSA might be unnecessary and potentially counterproductive.
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You'll need a lot, but not that much
There's no doubt healthcare is one of the biggest expenses retirees face, but at some point, money in your HSA could be more useful elsewhere. According to Fidelity, the average retired couple age 65 in 2022 will need around $315,000 to cover healthcare expenses in retirement. Add in the fact that many Americans retire at age 62, which is three years before they're eligible for Medicare, and there's no denying how important HSAs can be.
However, since you can only use the money in your HSA for qualified medical expenses, you begin to limit yourself in other areas once you begin contributing too much. If you're under age 65 and use the money in your HSA for a nonqualified medical expense, you'll pay income tax and a 20% withdrawal penalty on the amount. Imagine if you saved $500,000 in your HSA, realized you'll only need $400,000, and withdrew $100,000. That alone would cost you a $20,000 fee, not even including the tax bill.
After reaching age 65, the penalty for non-medical expense withdrawals goes away. However, you'll still owe taxes on money withdrawn for purposes other than paying healthcare expenses.
Of course, everybody's health situation is different, and some people will require much more medical attention (and money) than others, but for the average person of good health, there's no reason to believe you'll have seven figures of medical expenses to warrant saving that much in your HSA.
HSAs aren't tax-friendly when inherited
Accumulating $1 million in an HSA wouldn't be "bad" if the account had favorable inheritance rules. If the beneficiary of your HSA is your spouse, the transfer of ownership is simple and straightforward: The account becomes theirs as is. However, if your beneficiary is not your spouse -- and say, your child, for example -- your HSA will become a taxable account, and whoever receives it will have to claim it as taxable income for the year of your death. Depending on how much is in the HSA, this could easily push them up a couple of tax brackets for the year.
Instead of solely focusing on maxing out your HSA and running the risk of not having enough uses for the whole amount, redirect some of those contributions into a retirement account, like an IRA. Both Roth and traditional IRAs can provide good tax breaks, but you can use the money for whatever you want in retirement; you're not restricted to qualified medical expenses.
