“HSAs offer more flexibility than many people realize and can play a valuable role in your broader financial plan”
Health Savings Accounts: Your Tax Savings, Your Children’s Tax Bill
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Once a week, I bike to our office here in Carmel Valley. It’s a great way to start the morning and kills two birds with one stone: my commute and my exercise for the day. As a result, I occasionally shop online for bike gear, so I see plenty of targeted ads. I usually find them annoying and a little creepy, but one caught my attention. A bike shop was advertising that you could buy a bike with Health Savings Account (HSA) funds, something I’d never seen before.
It turns out there’s a little more to it than the ad suggests. Retailers use platforms like Truemed to connect you with a licensed healthcare provider who determines whether the purchase is medically necessary. If so, they issue a letter supporting the use of HSA funds for the purchase, though the letter alone does not guarantee that the expense qualifies under IRS rules.
In my case, I didn’t qualify. I just wanted a lighter bike, so I’d have less weight to haul up the hill, and apparently that doesn’t count as a medical necessity. Jokes aside, the ad got me thinking about how useful an HSA can be beyond just paying for medical bills. HSAs offer more flexibility than many people realize and can play a valuable role in your broader financial plan. These six tips can help you make the most of your HSA.
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1. California and New Jersey Treat HSAs Differently
California and New Jersey treat HSA contributions and investment earnings differently from the federal government. At the federal level, eligible contributions are deductible or excluded from income, and investment earnings are federally tax-free when withdrawn for qualified medical expenses.
However, California and New Jersey do not provide the same HSA tax benefits. Personal contributions are not deductible for state income tax purposes, and employer contributions are included in state taxable income. In addition, interest, dividends, and realized gains are generally taxable each year, even when the money stays in the HSA.
Transaction / Activity | Federal treatment | California and New Jersey treatment |
Eligible contributions | Deductible or excluded from income | No HSA deduction or exclusion |
Interest, dividends, and realized gains | No current tax within the account | Generally taxable annually, subject to state exemptions |
Qualified medical withdrawals | Tax free | Contributions and previously taxed earnings establish state tax basis and are not taxed again when withdrawn. Selling investments may generate taxable gains. |
Nonmedical withdrawals | Income tax, plus a possible 20% additional tax before age 65 | Contributions and previously taxed earnings establish state tax basis and are not taxed again when withdrawn. Selling investments may generate taxable gains. |
HSA custodians generally don’t issue tax forms for activity within the account, the way a brokerage account would issue a 1099. Residents of these states should provide their tax preparer with contribution records, investment statements, and transaction history to report taxable earnings and track investment cost basis.
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2. HSAs Can Reimburse Medical Expenses Years Later
One useful feature of an HSA is that you don’t have to reimburse yourself immediately. You can pay a qualified medical expense out of pocket and pay yourself back years later. The key is that the expense must have occurred after your HSA was established, but you don’t need to have enough money in the account to cover the entire expense at that time. You can make eligible contributions to the account later and use those funds to reimburse yourself. Keep the receipts and proof of payment, and make sure the expense wasn’t reimbursed elsewhere or claimed as a federal itemized deduction.
For example, suppose you incur a $2,000 medical bill after establishing your HSA, but the account only has $500 in it. You could pay the bill from your checking account and reimburse yourself once your HSA has enough funds. If you can comfortably cover the expense out of pocket, you could leave your HSA money invested and pay yourself back years later. That gives your investments more time to potentially grow, although a market downturn could also reduce the amount available when you’re ready to reimburse yourself.
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3. The Withdrawal Rules Change at Age 65
Unlike Flexible Spending Accounts (FSAs), you can carry over unused HSA funds indefinitely, and once you turn 65, you can use HSA funds for nonmedical expenses without the additional 20% penalty tax. You still pay ordinary federal income tax on those nonmedical withdrawals, similar to a withdrawal from a traditional IRA.
Qualified medical withdrawals, however, remain federally tax-free. So while you could use your HSA for a vacation, using it for eligible healthcare expenses preserves the full federal tax benefit.
At 65, you can also use HSA funds tax-free at the federal level for Medicare premiums, including Parts B and D and Medicare Advantage (private plans that provide your Medicare benefits), but not Medigap premiums (supplemental insurance that helps cover original Medicare’s out-of-pocket costs). Enrolling in Medicare ends your eligibility to contribute to an HSA for the months you’re covered, but you can continue using the money already in the account. Because Medicare coverage can be retroactive, confirm your coverage start date before determining your final HSA contribution amount.
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4. HSAs Are Portable
If you’ve changed jobs over the years, you may have HSAs with several custodians from previous employers. We often see the same thing with new clients’ old 401(k)s. Each account has its own login and password, and sometimes very different investment allocations. You can transfer those old HSA balances directly to your current HSA or another HSA of your choice without triggering federal income tax. If investments must be sold before the transfer, any gains may still be taxable in California or New Jersey. Bringing those accounts together can simplify recordkeeping and make it easier to manage your HSA investments as part of one cohesive strategy.
Before transferring, ask your custodian if there are any transfer or account closure fees. Also, make sure you take the time to download your statements, medical receipts, and reimbursement history. Moving the money doesn’t necessarily move those records, and you may lose access to their online portal once the account is closed.
A note on transfers
You can transfer money directly between HSA custodians as often as you’d like. However, if you receive the money yourself, you must deposit it into another HSA within 60 days. These indirect rollovers are limited to one in any rolling 12-month period across all your HSAs.
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5. Help Your Adult Children Save More With an HSA
With an HSA, parents have an opportunity to help their adult children save during the transition from college to working life. Children can generally remain on a parent’s health plan until age 26, even after they no longer qualify as tax dependents. That overlap, often at ages 24 and 25 but sometimes earlier, can allow a child on the family’s HSA eligible health plan to fund their own HSA at the full family contribution limit. The child must not be eligible to be claimed as anyone’s tax dependent. The word “family” in family contribution limit refers to the health insurance coverage, not whether the child is married or has children. That means for 2026, an eligible child could contribute up to $8,750 to their own HSA, in addition to the $8,750 the parents can contribute collectively, assuming everyone qualifies for the full year.
Parents can gift the money for the contribution to the child, and the child can receive a federal income tax deduction, even if they don’t itemize. Unlike an IRA, an HSA does not require earned income to contribute. If the child has little or no taxable income, the deduction may offer little or no immediate tax savings. The money can still grow free of federal income tax and be withdrawn without federal tax to pay qualified medical expenses.
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6. HSAs Can Be a Good Account to Leave to Charity
HSAs are known for their triple federal tax benefits on contributions, investment growth, and withdrawals for qualified medical expenses, but they can create a tax bomb for your children when inherited.
When a spouse is named as your beneficiary, they can keep the account as their own HSA. However, when a child or another individual inherits it, the account stops being an HSA, and the account’s value on the date of your death becomes taxable income to that person in the year you die, reduced by any of your qualified medical expenses incurred before death that the beneficiary pays within one year afterward. A large balance could push them into a higher tax bracket, especially during their peak earning years.
If charitable giving is already part of your estate plan, consider naming a qualified charity as the beneficiary. The charity can generally receive the money without paying income tax, allowing the full amount to support its work while you leave other assets to your family. For married couples, one approach is to name the spouse as the primary beneficiary and the charity as the contingent beneficiary, so the spouse retains access to the account if they survive you.If your spouse inherits the HSA, they should update their own beneficiary designation to reflect their charitable wishes.
If you’re interested in making the most of your HSA, reach out to our team at Pacific Wealth Management. We can help you evaluate how it fits into your broader financial plan and coordinate with your tax advisor.
Disclaimer: This material is provided for educational purposes only and is not intended as individualized investment, tax, or legal advice. The strategies discussed may not be appropriate for everyone. Tax treatment depends on individual circumstances, and federal and state tax laws are subject to change. Consult your tax advisor and, where appropriate, your estate planning attorney before implementing any strategy discussed. Investing involves risk, including the potential loss of principal.
Sound Management for your Secure Future
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Pacific Wealth Management is a fee-based, fiduciary firm offering comprehensive Retirement Planning expertise.
Our disciplined retirement planning process includes:
· Goals Based Needs Analysis
· Social Security Planning
· Long term Projections
· Monte Carlo Analysis
· 401(k), 403(b), 457 retirement plan analysis
· Retirement Distribution Strategies
Pacific Wealth Management, LLC
11512 El Camino Real, Suite 350
San Diego, CA 92130
858.509.9797
www.pacwealth.com
11512 El Camino Real, Suite 350, San Diego, CA 92130 · 858.509.9797 · Fax 858.509.9984 · E-mail: contactus@pacwealth.com
Financial planning and investment advisory services offered through Pacific Wealth Management, LLC ("PWM"), Registered Investment Advisor. This information is provided for general information purposes only and is not intended to provide specific investment advice. The information in this report should not be relied upon for tax reporting, accounting, or valuation purposes. The opinions referenced are as of the date of the communication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Some of the information given in this publication has been produced by unaffiliated third parties and, while it is deemed reliable, PWM does not guarantee its accuracy and makes no warranties with respect to results to be obtained from its use.This commentary contains forward looking statements and opinions, which may not develop as predicted. It is our goal to help investors by identifying changing market conditions; however, investors should be aware that no investment advisor can predict changes that may occur in the market.