Healthcare isn't cheap. And it's showing no signs of getting cheaper anytime soon. In 1970, total health spending in the U.S. was $74.1 billion. By the end of 2020, this number had skyrocketed to $4.1 trillion -- triple what it was in just 2000.

Unfortunately, retirees are feeling a lot of the effects of these increased costs. According to Fidelity, the average retired couple age 65 in 2022 will need around $315,000 (after taxes) for healthcare expenses alone. The true amount will undoubtedly vary because everyone's health situation is different, but healthcare in retirement won't be cheap for most people.

To prepare for the increased healthcare expenses you're likely to see in retirement, you should start early by utilizing a health savings account (HSA).

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Image source: Getty Images.

How an HSA works

An HSA is a tax-advantaged account that lets those who are eligible save and invest pre-tax money to use for qualified medical, dental, and vision expenses for you, your spouse, and dependents. As long as you have a high-deductible health plan (HDHP), you're eligible to contribute. 

You can either have HSA contributions taken directly from your paycheck, like a 401(k), or you can contribute after-tax money and deduct the contributions from your taxable income for the year. Here are the 2022 contribution limits for an HSA: 

Coverage Type Contribution Limit Contribution Limit for People 55 and Older
Self only $3,650 $4,650
Family $7,300 $8,300

Data source: IRS.

If you're going to be spending money on medical expenses, you might as well save for it and get a tax break along the way. It's a win-win: You save for inevitable expenses and get to lower your taxable income while doing it.

Do more than just save

Part of the appeal of an HSA is that you can invest the money in the account; it's not just sitting around like a traditional savings account. Saving $315,000 by strictly saving and not investing may be possible for retirement as a whole, but asking someone to do that for healthcare expenses alone is a tough ask. Growing your money over time is one of the surest ways to ensure you're financially prepared for healthcare expenses in retirement.

Suppose you have single coverage and contribute $300 monthly to an HSA (just below the 2022 annual limit). If you invest your contributions into an index fund with 8% average annual returns, you could accumulate around $314,400 in 27 years -- just below the estimated $315,000 Fidelity says a retired couple will need.

Not only would that nest egg be incredibly valuable to cover your health needs, but the full amount would be tax-free if you use it on eligible healthcare expenses.

Eligible HSA expenses

Eligible HSA expenses include but are not limited to:

  • Doctor/hospital copays
  • Surgeries
  • Physical therapy
  • Birth control/contraceptives
  • Teeth cleanings
  • Dental surgeries
  • Eye exams
  • Eye surgeries
  • Prescription eyeglasses and sunglasses

The list of eligible expenses is extensive, and you may be surprised by what an HSA can cover. Be sure to double-check if any of your medical expenses qualify before using your HSA money.

An HSA can help fill in the gap

Medicare is the United States' health insurance program for people age 65 or older (there are some medical exceptions to the age limit). Since many people retire before 65 and will no longer have health insurance through their employer, they could have a coverage gap. Or maybe they get insurance through the government marketplace but can't afford a plan comprehensive enough to cover their needs. Either way, it's crucial to have additional income sources to help cover healthcare costs in those years.

You don't want to pay out-of-pocket for your healthcare expenses, so it's important to be insured. But sometimes, life happens, and that's the situation you find yourself in. Growing your money in an HSA over time is the best way to make sure you're ready if you qualify to contribute to one.