People usually think of a 401(k), IRA, or Roth IRA when it comes to retirement accounts, but the health savings account (HSA) rarely comes to mind. HSAs might not be designed specifically for retirement, but they can be a powerful piece of anyone's financial plan. That's especially true for seniors.

How the HSA works

HSAs are one way that the U.S. government encourages people to save for medical expenses. They allow people who have high-deductible health plans to set money aside for costs that aren't covered by insurance, such as copays.

HSA contributions are tax deductible, so they're popular with accountants. If there's no immediate need for medical care, these assets can be invested over time for growth until there's a cash need. It can function as a rainy day fund for anyone who recognizes that they'll incur medical expenses at some point in the future. The investment options vary among providers, but most offer a range of mutual funds or exchange-traded funds, along with tools to figure out the best allocation. Some even allow you to buy individual stocks and bonds. In any case, the returns generated in the HSA accumulate tax-free. 

Piggy bank next to a jar full of money labeled "HSA" against a blue background.

Image source: Getty Images.

When the time comes to pay for eligible healthcare expenses, distributions can also be made tax-free. A wide range of medical, dental, mental health, and vision costs qualify for tax-free distributions. This completes the "triple tax benefit" that can be worth thousands of dollars to people taking full advantage of these accounts.

HSA contribution limits are based on your health insurance plan. People with individual-only coverage can contribute up to $3,850 in 2023, while people with family coverage can deduct $7,750 annually. People 55 or older have even higher limits due to catch-up provisions. Unlike certain retirement accounts, HSAs have no income limits.

The HSA's major drawback is that it imposes penalties on non-qualifying distributions in some cases. If you need to withdraw cash for ineligible expenses, the distributions will be treated as ordinary income for taxes, with an additional 20% penalty assessed if you're younger than 65. As with other qualified accounts, you shouldn't overextend yourself to utilize these vehicles. Instead, they should be one tool that works harmoniously with others in a financial plan.

Why HSAs are so great for retirees

HSAs combine popular features of the 401(k) and Roth IRAs. Like a 401(k) or traditional IRA, HSA contributions are made pre-tax, giving account holders an opportunity to generate returns on earnings before the IRS takes its cut. The extra boost from the tax deduction can really add up over time. Like a Roth IRA, qualifying distributions are also tax-free. You generally have to pay taxes on 401(k) withdrawals, and Roth contributions aren't deductible. The HSA creates a best-of-both-worlds situation that can allow you to circumvent taxation altogether. That's not really a feature of any other retirement account.

HSAs provide an extra benefit for retirees that isn't available to younger account holders. In the event that a senior aged 65 or older has assets in a health savings account without any qualifying medical expenses, they can make withdrawals without a penalty. The distribution will still be treated as ordinary income for tax purposes, so it essentially functions like a 401(k) or traditional IRA, but with an extra perk.

Seniors spend over $4,000 annually on medical costs, on average. That amount is subject to rising prices that have typically outpaced the overall inflation rate, and healthcare spending typically increases as people get into the later years of retirement. That can be a major issue for elders on a fixed income.

There's a strong chance that retirees will have an opportunity to take full advantage of the HSA's tax benefits, and there is no more efficient vehicle for healthcare savings.