Traditional retirement savings plans like 401(k)s and IRAs can go a long way in helping you prepare for retirement. However, these account types can also become ticking time bombs for unprepared taxpayers. Because of mandatory distribution rules and age limits, taxpayers may not be able to withdraw their funds when they need them, or they may be required to withdraw more than they need in order to avoid paying a penalty. Not only that, those mandatory distributions might happen at the worst possible time tax-wise—when you are in a high tax bracket and don’t have easily accessible ways to lower your taxable income.
Retirement planning is not one-size-fits-all. This is why some taxpayers can rely largely on traditional retirement accounts and others need alternative strategies to keep taxes low. Today, we’ll discuss how to use health savings accounts (HSAs) and 401(h) plans as a powerful retirement planning tool.
How do HSAs work?
Health savings accounts have so much going for them: greater flexibility, greater control, and greater tax savings. An HSA is intended to help taxpayers save money to cover qualified medical expenses. The range of expenses covered is expansive and includes copays, dental care, eyeglasses and contact lenses, prescriptions, X-rays, and much more. To be eligible to set up an HSA:
• You must be covered by a high deductible health plan (HDHP)
• You must not have any other health care coverage (unless it meets IRS guidelines)
• You cannot be enrolled in Medicare
• You cannot be claimed as a dependent on someone else’s tax return for that tax year
If you’re not sure if you have a high deductible health plan, the IRS provides a detailed description of what counts. Additionally, the recent “One Big Beautiful Bill” Act expanded the definition of an HDHP to include Bronze and Catastrophic ACA Marketplace plans, increasing the number of Americans who are eligible for an HSA.
HSAs do have contribution limits:
• For 2025: $4,300 for individuals and $8,550 for families
• For 2026: $4,400 for individuals and $8,750 for families
HSAs offer a triple tax advantage:
1. Lower taxable income—just by making contributions
2. Tax-free growth—from any investment earnings while the funds are in the account
3. Tax-free withdrawals—as long as funds are used for qualified medical expenses
To take advantage of these benefits, all you have to do is start making contributions. In some cases, your employer might also offer to contribute to your HSA as an employee benefit, much like a 401(k) match. Unlike other savings vessels like flexible spending accounts (FSAs), an HSA does not have a “use it or lose it” rule, and you do not forfeit your HSA if you leave your employer. Any money you don’t use in a given year is automatically carried forward. You are also able to invest your HSA funds and increase your total health care savings.
What limitations do HSAs face?
One restriction is that you have to wait until age 65 to withdraw money from your HSA without penalty. However, this can actually be a benefit rather than a drawback. Why? The best practice for maximizing your HSA is not to use it to pay your medical bills before retirement. Instead, you want to pay your current expenses out-of-pocket, save your receipts, and let your HSA investments grow. Because here’s the real cash cow: an HSA has no time limit on reimbursements. That means if you retire in 10 years, as long as you document this year’s medical expenses, you can reimburse yourself using HSA funds a full decade later. Just keep in mind that you cannot seek reimbursement if those expenses have been paid for by another plan or if you listed them as itemized tax deductions.
The other catch with an HSA is that the tax benefits only kick in if you use the money for medical expenses. However, this may not be as restrictive as it sounds. Even diligent savers often underestimate how much they need to cover health care costs as they age. A 2024 report by Fidelity titled “Retiree Health Care Cost Estimates” found that a couple retiring at age 65 will spend an average of $330,000 on medical expenses over the course of their retirement years. So one of the wisest things you can do as you plan for retirement is look for tax-advantaged ways to save for future medical costs. An HSA provides an ideal way to do just that.
What happens if you need to withdraw funds from your HSA to cover non-medical expenses? If you are aged 65 or older, you can use these funds for other expenses without a penalty, but you will have to pay ordinary income tax on the withdrawn funds. The key to minimizing taxes is to avoid any withdrawals before age 65. Before age 65, you will face a 20% penalty on any withdrawals on top of regular income tax.
What are the tax benefits for 401(h) Accounts?
If your employer offers a 401(h) plan—or you are a business owner considering setting this up—this can be another powerful tax savings tool. These health savings retirement plans must be sponsored by a business or organization. They are basically health expense accounts attached to a cash balance plan. 401(h) plans are most commonly used by highly-compensated employees or business owners.
Depending on the terms of your specific plan, the account may be able to receive both employer and employee contributions. Any contributions result in lower taxable income—either for the employer or employee who contributes the funds. Like with an HSA, 401(h) withdrawals are tax-free as long as they are used for qualified medical expenses. Any earnings generated while the funds are in the account are also tax-free. So again, we have a triple tax advantage here:
• Contributions lower your taxable income
• Earnings within the account are tax-free
• Distributions are tax-free as long as they go to qualified medical expenses
Fortunately, you can also use a 401(h) plan to cover your dependents, including children and elderly parents. If you are eligible for a 401(h), this can provide many of the same benefits as an HSA and set you up for more tax-advantaged retirement savings. A 401(h) does have one advantage over an HSA: You can make penalty-free withdrawals starting at age 59 ½, according to a 2023 IRS ruling.
Summary
HSAs and 401(h) plans offer major tax advantages we don’t see even with our other alternative retirement strategies like captive insurance or IC-DISCs . The ability to invest and grow your funds tax-free in a health savings account is an incredible benefit hard to find elsewhere. Though you will face the restriction that funds can only be used for medical expenses, this also serves as a wise retirement strategy, since a large portion of the average retiree’s savings end up allocated to health care, anyway. Plus, since there is no time limit on reimbursements, you can repay yourself for current medical expenses years down the line and enjoy all three of those tax benefits.
Looking for new ways to save for the future while saving on this year’s tax bill? Reach out to a Certified Tax Planner today.
