Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Use a Health Savings Account
Transcript
- Lucas: Alright, so we talk a lot about the 401k, the IRA, the taxable brokerage. But there's one account that I think flies under the radar for early retirees, and it's the health savings account, or HSA. Luna: The HSA. I feel like everyone knows it exists, but almost nobody treats it like the powerhouse it actually is. Lucas: Exactly. And I think the reason it's underrated is that people see the words 'health savings' and they think, okay, it's just a pot of money for doctor bills. But the HSA is the only account in the US tax code that gives you a deduction on the way in, tax-free growth, and tax-free withdrawals when you use it for qualified medical expenses. Luna: Triple tax advantage. That's not hyperbole, that's actually the law. Lucas: Right. And for an early retiree, it's even more powerful because you have this gap between when you stop working and when Medicare kicks in at 65. That's potentially a decade or more where you're buying your own health insurance, and medical expenses tend to be one of the biggest wildcards in a retirement plan. Luna: So how do you actually use an HSA strategically? I mean, you can't just open one if you're not on a high-deductible health plan, right? Lucas: Right. The eligibility rule is that you need to be enrolled in a high-deductible health plan, or HDHP. For 2026, the IRS defines that as a plan with a deductible of at least $1,650 for an individual or $3,300 for a family. And your out-of-pocket maximum can't exceed $8,300 for self-only or $16,600 for family coverage. Luna: Those numbers matter because if your plan's deductible is too low, you're out of luck. Lucas: Exactly. So the first step, if you're still working and you have access to an HDHP, is to max out your HSA contributions. For 2026, the limit is $4,300 for self-only and $8,550 for family coverage. And if you're 55 or older, there's a catch-up contribution of $1,000 on top of that. Luna: Those limits are actually pretty generous. And they tend to go up every year with inflation, which is nice. Lucas: They do. But here's where the strategy kicks in. The common mistake is to use the HSA to pay for every medical expense as it comes up. You go to the doctor, you swipe the HSA debit card, and the account slowly drains. That's fine if you're using it as a spending account, but it's not using it as an investment vehicle. Luna: So the alternative is to pay for current medical costs out of pocket and let the HSA grow. I've heard that called the 'pay and reimburse' strategy. Lucas: That's exactly it. You keep your receipts, you pay with cash or a credit card, and you let the HSA balance sit in index funds. Decades later, when you're older and medical expenses are higher, you can reimburse yourself for those old out-of-pocket costs, tax-free. And the money you didn't spend has been compounding the whole time. Luna: So it's kind of like a second IRA that's triple tax advantaged, but you have to get through the HDHP hurdle first. Lucas: Yeah, and that's the trade-off. An HDHP usually has lower premiums but higher deductibles, so you're taking on more risk in the short term. But if you're healthy and you have the cash flow to cover the deductible if something happens, the HSA can be a phenomenal long-term tool. Luna: And it's not just for medical expenses. After 65, you can withdraw from an HSA for any reason without penalty. You just pay ordinary income tax, like you would from a traditional 401k. Lucas: Right. So it becomes a stealth retirement account. Before 65, if you take a non-medical withdrawal, you pay a 20 percent penalty plus income tax, so that's a serious disincentive. But after 65, it's just a regular retirement account with a bonus: if you do use it for medical expenses, those withdrawals are completely tax-free. Luna: That's a nice flexibility. But there's a big gotcha with Medicare, isn't there? Lucas: Oh, yeah. Once you enroll in Medicare, you can't contribute to an HSA anymore. And the rule is retroactive for the month you're enrolled. So if you're planning to work past 65, you need to be careful about timing. But for early retirees, that's less of an issue because you're usually enrolling in Medicare at 65 anyway. Luna: But what about using the HSA to pay for Medicare premiums? I've heard that's allowed. Lucas: Yes, you can use HSA funds to pay for Medicare Part B and Part D premiums, and even Medicare Advantage premiums. But you can't use them to pay for Medigap policies. That's an important distinction. Luna: Good to know. So if you're in that pre-Medicare gap, you're mostly using the HSA for out-of-pocket costs, not for premiums, because your marketplace premiums aren't qualified expenses. Lucas: Right. Marketplace premiums don't count. So you have to be strategic about which bills you route through the HSA and which you pay out of pocket. Luna: So let's say I'm 50, I retire early, and I have an HSA with $100,000 in it. What's the smartest way to use that money over the next 15 years? Lucas: Well, the first thing is, don't contribute anymore, because you're no longer on an HDHP. Unless you have a part-time job with an HDHP, which some people do. But if you're fully retired, you're done contributing. The account is now a tool for covering healthcare costs in the gap. Luna: And you want to be thoughtful about how you draw it down, right? Because you don't want to blow through it too fast. Lucas: Exactly. A common approach is to use the HSA for larger, predictable expenses like dental work, vision, or a planned procedure, and pay for routine stuff out of pocket. That way you're not draining the account for small stuff, and you're preserving the tax-free growth for later. Luna: And then when Medicare kicks in, you can use the HSA for premiums and co-pays, and it becomes a nice buffer for long-term care costs, which can be huge. Lucas: Totally. And one thing I want to mention, because it's easy to overlook, is the investment side. Many HSA providers keep your money in cash by default, earning next to nothing. You have to actively choose to invest in mutual funds or ETFs. It takes two minutes, but most people never do it. Luna: Yeah, I've seen that too. You have to opt in. And it's a shame because that's where the compounding magic happens. Lucas: So the takeaway is, if you have access to an HSA, treat it as a retirement account, not a spending account. Max it out, invest the balance, and keep your receipts. Luna: And speaking of keeping things simple, I love that we keep this show ad-free. It makes these conversations feel more like a friend explaining something over coffee. Lucas: Yeah, and if you want to support that, the link is buy me a coffee dot com slash fexingo. It's a small way to keep the podcast independent. Luna: Right. No pressure, just if it's helped you. So back to HSAs—what about the 20 percent penalty before 65? How do you avoid that if you need the money for something non-medical? Lucas: Well, the penalty is a big deterrent, but there are some exceptions. Disability, for example, or if you become unemployed and you're on COBRA for 12 months. But those are narrow. The best way to avoid it is to just not withdraw for non-medical reasons before 65. Luna: So you keep it as a dedicated healthcare fund until then. That makes sense. Lucas: And if you do have a large medical expense, you can reimburse yourself right away, but you might want to let it ride and use other accounts for income. It's a balancing act. Luna: One more thing: what happens to your HSA if your spouse inherits it? Does it stay tax-free? Lucas: If the spouse is the designated beneficiary, they can roll it into their own HSA, and it keeps its tax-free status. If it goes to a non-spouse, it becomes taxable income in the year of the owner's death, and the account is closed. So it's worth naming your spouse as beneficiary. Luna: That's a good reminder. Estate planning and HSA planning go hand in hand. Lucas: Definitely. So, as we wrap up, I'd say the HSA is one of the most underused tools in the early retirement toolkit. It's not glamorous, but it's reliable and it has a unique tax structure that you can't get anywhere else. Luna: And if you're still working and have an HDHP, it's a no-brainer to at least contribute up to the match, if your employer offers one. Lucas: Right. Even if you don't retire early, the HSA is a great complement to your retirement savings. So next time you're reviewing your portfolio, don't forget the health savings account. Luna: Well said. That's what we've got for today. Talk to you next time.