Can My HSA Take the Place of an IRA?

HSAs, or health savings accounts, have been growing more and more popular. As of late 2022, almost 72 million people had an HSA, compared to 67 million in 2021 (according to Devenir).

Now, the nice thing about having an HSA is that you can set aside money for healthcare expenses on a pre-tax basis. In other words, if you put $1,000 into an HSA, you won't pay taxes on that portion of your income.

HSAs then allow you to use your money whenever you want. Unlike FSAs (flexible spending accounts), they don't force you to deplete your plan balance year after year. Quite the contrary -- HSAs allow you to invest money you don't need right away to grow your balance into a larger sum. In fact, a good strategy is to save in an HSA during your working years, invest that money, and kick off retirement with a large sum earmarked for healthcare expenses. 

You should also know that HSA withdrawals are tax-free when used to cover medical expenses. This holds true whether you take an HSA withdrawal in your 30s or in your 60s. 

As you might imagine, you'll face a penalty for taking an HSA withdrawal for a non-medical expense. But once you turn 65, that penalty goes away, and you can take HSA withdrawals penalty-free for any purpose. In that situation, you simply pay taxes on your withdrawal, the same way you would with a traditional IRA withdrawal.

Because of that, you may be wondering if you actually need an IRA if you're going to be saving and investing in an HSA. But there's a very good reason why it's best to have an IRA along with an HSA. 

You need an account you can't touch right away

The money in your HSA can be withdrawn at any time to cover qualified healthcare expenses. Because of this, it's dangerous to have your HSA take the place of an IRA.

Let's say you're 45 and you want to take an HSA withdrawal of $3,000 to cover a medical bill you've incurred. You have every right to do that -- that's what the money is for. But if that HSA is also doubling as your retirement savings plan, and you keep taking withdrawals ahead of retirement, you'll risk closing out your career without having amassed enough money to cover your senior living costs.

That's why you're really better off having both an IRA and an HSA. The former is an account you should pledge not to touch until retirement age (and if you take withdrawals prior to age 59 1/2, you'll face penalties). But the latter is an account you may need to dip into to cover medical bills so healthcare expenses don't drive you into medical debt. 

HSA eligibility isn't guaranteed

Another reason your HSA can't take the place of an IRA? You can contribute to an IRA as long as you have earned income. But HSA eligibility hinges on your health insurance plan meeting certain criteria that can change from year to year. And it may be that you're able to contribute to an HSA one year, but not the following year.

As an example, this year, you need a minimum individual deductible of $1,500 for your health insurance plan to be compatible with an HSA. Next year, that limit is rising to $1,600. If your current deductible is $1,500 but it doesn't rise in 2024, then HSA contributions will be off the table for you next year, even if you were able to make them this year.

All told, it's good to fund an HSA if you're eligible. But it's also important to contribute regularly to an IRA for retirement. And you shouldn't let your participation in one account prevent you from contributing to the other.