How to Avoid HSA Tax Traps in Retirement

Disclosure: Before making any decisions related to your HSA, please consult with a tax professional.

Health Savings Accounts (HSAs) are often praised for their powerful tax advantages. Most of the conversation tends to focus on contributions – and for good reason. While you’re healthy and working, maximizing HSA contributions can be a smart move. But at some point, you’ll need to think about how to take money out of the account in the most tax-efficient way.

HSA Basics: Triple Tax Advantage

In 2025, an HSA-eligible individual (meaning someone with a high-deductible health plan and not enrolled in Medicare) can contribute up to:

• $4,300 for self-only coverage
• $8,550 for family coverage
• $1,000 catch-up contribution if age 55 or older 

Contributions are tax-deductible, earnings grow tax-free, and distributions are tax-free when used for qualified medical expenses. This “triple tax benefit” makes HSAs one of the most effective long-term savings tools available.

Related: How to Maximize Your Health Savings Account (HSA)

When and How to Use HSA Funds

Because of their tax advantages, HSAs are often the last account people touch in retirement. But deferring withdrawals indefinitely isn’t always the best strategy. 

If you pass away with a balance in your HSA and name a non-spouse beneficiary, the remaining funds become fully taxable in the year of death (with the exception of amounts used to pay for any outstanding medical bills within one year of your passing). For this reason, it can be beneficial to begin using HSA funds strategically during retirement.

A Common Strategy: Pay Yourself Back

One approach is to use HSA funds to reimburse yourself for Medicare premiums. For example, in 2025, the standard Medicare Part B premium is $185 per month. That’s $2,220 per year, which you can withdraw tax-free from your HSA – effectively reimbursing yourself for premiums that were deducted from your Social Security check.

In addition to Medicare premiums, other qualified medical expenses can be reimbursed from your HSA. These include unreimbursed costs for doctors visits, prescriptions, hospital stays, and dental or vision care – essentially, any expense that would qualify for the medical and dental deduction under IRS Publication 502.

What About Insurance Premiums?

HSA funds cannot be used to pay most health insurance premiums – unless the premiums fall into one of the following categories:

• Medicare premiums (excluding Medigap) for individuals age 65 or older
• COBRA premiums
• Long-term care insurance premiums
• Health insurance while receiving unemployment compensation

So, for example, an early retiree who loses employer coverage and isn’t yet eligible for Medicare cannot use HSA funds to pay for marketplace insurance premiums. If they’re not on COBRA, they’ll need to cover those premiums out of pocket – even if they qualify for subsidies. 

Still, between Medicare premiums, long-term care costs, and other qualified out-of-pocket medical expenses, most retirees will find ample opportunities to tap into their HSA without incurring taxes.

HSA distributions must be reported each year using IRS Form 8889. As long as all distributions are used for qualified medical expenses, you won’t owe any tax. As always, consult with your tax professional on all tax-related matters.

Final Thoughts

An HSA isn’t just a savings account for today’s medical expenses – it can also be a powerful retirement planning tool. By understanding the rules around distributions and planning accordingly, you can make the most of your HSA and avoid unwanted tax surprises down the road.

If you have any questions about HSAs or would like to speak to someone from the Bautis Financial team, you’re welcome to schedule a complimentary consultation using the link below.

Bautis Financial LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.