Why some advisors prefer HSAs over IRAs for retirement savings

Some clients might be better off stocking a health savings account to the gills and leaving it relatively untouched — not even using it to buy so much as a box of Band-Aids — according to some financial advisors.

Since HSAs launched just over 20 years ago, many advisors have started recommending a strategy of using the accounts as another form of retirement account, particularly for health care expenses but even for unrelated expenses. Once in retirement, there is no penalty for spending HSA funds on non-medical expenses. There would only be taxes due, as with distributions from a traditional individual retirement account.

At face value, HSAs seem to be for short-term or medium-term medical expenses — a way to take on those bills with untaxed dollars. But according to this strategy, it would be better to pay for medical expenses out of pocket to maximize funds in the HSA for investing and tax-free growth.

Advisors also recommend contributing as much as possible to HSAs and using payroll deductions to save both income and payroll taxes. The maximum HSA contributions for 2026 are $4,400 for self-only coverage and $8,750 for family coverage, and clients must have a high-deductible health plan.

READ MORE: How advisors can help clients navigate medical debt and plan for emergencies

Benefit from tax-free growth

Most HSA custodians allow accountholders to invest their savings, though many require a minimum cash balance, such as $1,000 or $2,000, before investing the remainder of the account. Advisors can remind clients to check their custodian's rules.

HSAs are a more valuable way for clients to invest their savings than if they used a regular brokerage account because, similar to a Roth IRA, growth on investments in an HSA is tax free.

"They can contribute to the HSA all the way up until they begin receiving Medicare, and at that point, they can have a nice little nest egg that can be used for long-term care expenses and things like that," Dale L. Shafer, founder, financial advisor and chief compliance officer of Scottsdale, Arizona-based Life Moves Wealth Management, told Financial Planning.

Medicare premiums are one type of health care expense that clients can cover with HSA funds in retirement.

READ MORE: Tips for using a 'medical IRA' that offers triple the tax savings

Advantages over IRAs

Ryan McKeown, senior vice president at Wealth Enhancement Group and based in Mankato, Minnesota, advises some clients who are at least 59 ½ years old to take money out of their IRAs and use it to make HSA contributions "because we feel HSAs are much better from a tax perspective than keeping the money in the IRA," he said in an interview.

Once clients are 59 ½ years old, the 10% penalty for early IRA withdrawals goes away, though the withdrawals are taxable.

"The deduction from making the HSA contribution with the cash flow from the distribution offsets the taxable income," McKeown added in an email.

Moving funds to an HSA could work out well because, when clients withdraw from an HSA for medical expenses, the distribution is tax-free. However, when they withdraw from an IRA, the money is taxable. Another advantage is that having a larger HSA balance maximizes the growth of that money that can later be withdrawn tax free for medical expenses.

Withdrawing funds from an HSA instead of an IRA has another advantage: not having to make required minimum distributions.

READ MORE: Inflation, health care costs top retirees' concerns, survey finds

It is a relatively new strategy to use an HSA as a retirement account, since HSAs were created by a federal law effective in 2004. Americans haven't yet had time to start HSAs at a young age and keep them for decades until retirement. Even so, advisors consider the strategy to be low-risk.

"I guess worst-case scenario is they pay tax on [HSA withdrawals] like they would an IRA or 401(k)," McKeown said in an interview. "But the best-case scenario, I think a more likely scenario, is that government expands the use of HSAs."

Health care expenses tend to rise in retirement

Some clients are reluctant to fund a long-term care insurance policy because they are expensive and use-or-lose, but HSAs are an alternative that can continue growing through retirement, said Heather Schreiber, founder and president of HLS Retirement Consulting. Health care is "one of the highest expenses that people really don't think about as they approach retirement," she added.

"I'm a real advocate of talking about that sort of unglamorous discussion about how health care expenses in retirement can really be a risk," Schreiber said in an interview. "There's a lot of risks that you're trying to mitigate in retirement," including those related to inflation, which can be double for health care compared with the overall rate.

READ MORE: Long-term care costs outpacing retirement income: AARP

"It gives them the ability to have a coordinated, flexible retirement income strategy that allows them to pull from those buckets for various expenses," Schreiber said. "The whole idea is to have the most tax-efficient retirement strategy as possible," and the HSA offers a "trifecta of opportunities."

Maximize savings for wealthy clients

Contributing to an HSA requires having a high-deductible health plan, and wealthier people are also more likely to be able to handle such a plan, since it trades lower premiums for higher out-of-pocket costs.

"When you're working with more affluent clients, they're usually limited on how much they can contribute to IRAs and to Roth IRAs, so they can only stuff so many dollars in those containers," said Jay Pelham, president of Miami-based registered investment advisor Kaufman Rossin Wealth.

In addition to not owing income taxes on interest or dividends, "you're not generating any capital gains tax" on investments held in an HSA, he added.