A health savings account (HSA) allows your clients to save for medical expenses. But combined with other investment tools, this growing but still largely underused tool can also help bolster retirement funding.

Pre-tax contributions grow tax-free in an HSA. Your client’s eventual distributions are also free of tax if your client spends them for qualified medical expenses.

“It’s another tax-deferred savings tool that can be used after your client maxes out on 401(k)s,” says Larry Pon, CPA at Pon & Associates in Redwood City, Calif. “I have a client who makes the maximum contributions to both the 401(k) and HSA. He has about $85,000 in his HSA. He’s planning on using the money to pay for long-term-care insurance premiums after he turns 65.”

In 2017, the maximum HSA contribution is $3,400 for an individual and $6,750 for a family (with $1,000 additional catch-up contributions for those 55 and older)—deductible from gross income. There are no required distributions, unlike with an IRA.

Studies show that HSAs are still typically underfunded, underused and little understood. “Many times retirees aren’t sure how the HSA plan works or how it’s used. It is not unusual to discover that a retiree may be covered by their spouse’s plan and yet they make contributions to an HSA, which isn’t allowed under the tax code,” says Jessica Grant, tax specialist at Smith & Gesteland in Madison, Wis.

In one strategy, a high-net-worth individual could contribute HSA monies for multiple years and fund deductible costs out of other personal assets during those years instead of using tax-deferred HSA assets, says Timothy Hilbert, a CPA and director of audit and accounting at Kreischer Miller in Horsham, Pa. “The HSA dollars can be invested, much like a 401(k) or IRA. Down the road, the funds, if used for qualified medical expenses, especially if used after age 65, are untaxed when paid out. If funds are withdrawn after age 65 for other than qualified medical expenses, they’re subject to ordinary income tax but no penalty.”

Self-employed, high-net-worth individuals can grab two deductions on their tax return: one for contributions to the HSA and one for self-employed health-insurance premiums, Grant points out.
 
“Non-qualified expenses used from the account are taxed the ordinary income rates and assessed an additional 20 percent penalty if the participant is under age 65,” adds Sterling Raskie, a CFP and advisor with Blankenship Financial Planning in New Berlin, Ill., and lecturer in finance at the University of Illinois Urbana-Champaign.

“If you contribute and deduct $500 to an HSA and then spend $500 on qualified medical expenses in the same year, you essentially move your $500 medical deduction away from Schedule A and its 10 percent threshold to the adjusted gross income section on the 1040,” adds Jean-Luc Bourdon, a CPA at BrightPath Wealth Planning in Santa Barbara, Calif. “In addition to increasing the amount deducted, you also reduce AGI, which can benefit various tax calculations.”

HSAs do, however, will require clients to enroll in health plans carrying big deductibles and out-of-pocket expenses—the latter being $13,100 for a family for 2017. Though your client can carry dental, vision, disability and long-term-care insurance, he or she can’t be covered by any other health insurance other than the HDHP, says Grant. Your client also can’t use HSA money to pay for over-the-counter medications and probably can’t use the account for what’s likely their biggest medical expense of the year: health-insurance premiums, says Christopher Wittich, a CPA and senior manager at Boyum & Barenscheer in Bloomington, Minn.

Nevertheless, “it’s worth keeping a close eye on HSAs if and when any health-care reform passes Congress,” Wittich says. “There have been discussions about changing contribution limits, changing the eligible expenses to allow for paying premiums and changing the penalty provisions for non-qualified distributions.”