You’ve likely heard the Health Savings Account (HSA) described as the ultimate retirement vehicle. Financial experts often call it the “triple threat” of investing: tax-free contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. For many, it effectively beats a 401(k) or IRA because it’s the only account that can be completely tax-free from start to finish.
But there is a catch. Actually, there are three.
While the benefits of an HSA are undeniable, the “perfect” retirement account has some serious flaws that rarely make the headlines. If you aren’t careful, these hidden pitfalls can trigger unexpected tax bills, erode your investment returns, or leave your heirs with a massive financial burden.
Here is the reality of HSAs that most brochures won’t tell you—and how you can navigate these traps to keep your retirement savings safe.
The Essentials: What You Need to Know
- The Medicare Trap: Contributing to an HSA while enrolled in Medicare (even retroactively) triggers IRS penalties.
- The Inheritance Bomb: Unlike an IRA, an HSA left to a non-spouse beneficiary is fully taxable in a single year.
- The “Cash Drag”: High fees and mandatory cash minimums can silently eat away at your long-term compound growth.
- 2025/2026 Limits: For 2025, you can contribute up to $4,300 (self) or $8,550 (family). These limits rise to $4,400 and $8,750 in 2026.
1. The Medicare “Clawback” Trap
The most dangerous hidden cost for retirees involves the transition to Medicare. Many seniors assume they can keep contributing to their HSA as long as they are working, even if they are approaching age 65. This assumption can lead to a messy tax situation.
Here is the rule: You cannot contribute to an HSA once you are enrolled in any part of Medicare (Part A or Part B).
The problem arises because most people don’t realize when their Medicare coverage actually begins. If you apply for Social Security at age 65 or later, you are automatically enrolled in Medicare Part A. More importantly, your Part A coverage is often retroactive for up to six months.
How the 6-Month Lookback Rule Burns You
If you retire at age 67 and apply for Social Security or Medicare, your Part A coverage will likely be backdated by six months to ensure you have no coverage gaps. The IRS considers you “enrolled” in Medicare during those six retroactive months.
If you made HSA contributions during that six-month window, the IRS considers them “excess contributions.” You will face:
- Income Tax: You must add those contributions back to your taxable income.
- 6% Excise Tax: You will pay a 6% penalty on the excess amount for every year it remains in the account.
The Fix: If you plan to enroll in Medicare or Social Security after age 65, stop all HSA contributions six months before your application date. This creates a safety buffer that prevents the retroactive coverage from overlapping with your contributions.
2. The “Beneficiary Tax Bomb”
We often think of HSAs as “super IRAs,” but they have a fatal flaw when it comes to estate planning. With a traditional IRA, if you pass away, your children (or other non-spouse beneficiaries) can typically spread distributions over 10 years, managing the tax hit. With a Roth IRA, they generally pay no tax at all.
The HSA rules are far more brutal.
If you leave your HSA to your spouse, it simply becomes their HSA. No taxes are due, and life goes on. However, if you leave your HSA to anyone else—your children, a sibling, or a friend—the tax shelter instantly collapses.
The entire value of the HSA becomes taxable income to your beneficiary in the single year of your death.
A Real-World Example
Imagine you diligently save $100,000 in your HSA for retirement healthcare costs. You pass away and leave the account to your adult daughter.
Unlike an inherited IRA, she cannot stretch this out. That entire $100,000 is added to her taxable income for that year. If she is already in a 24% tax bracket, this inheritance could push her into the 32% or 35% bracket, causing her to lose nearly a third or more of your hard-earned savings to the IRS immediately.
“If your goal is to leave a legacy, the HSA is one of the least tax-efficient assets to leave to anyone other than your spouse.” — Ed Slott, CPA and Retirement Expert
The Fix: Prioritize spending down your HSA money during your lifetime for medical expenses. If you have other assets, use your HSA funds for healthcare first, allowing your more inheritance-friendly assets (like Roth IRAs or brokerage accounts with a step-up in basis) to grow for your heirs.
3. The “Cash Drag” and Fee Erosion
When you invest in a 401(k), you typically put 100% of your money to work in the market immediately. HSAs rarely work this way. Many HSA providers act more like banks than brokerages, and they structure their accounts to ensure they make money on your deposits.
The Mandatory Cash Minimum
Many HSA administrators require you to keep a minimum balance in a low-interest cash account before you are allowed to invest a penny. This threshold is often $1,000 or $2,000.
This is known as “cash drag.” If you have a $3,000 balance and a $2,000 cash minimum, only $1,000 is actually working for you in the market. The other $2,000 is likely earning less than 0.5% interest, losing value to inflation every single year.
The Layered Fees
In addition to cash drag, watch out for these common fees that eat away at small balances:
- Monthly Maintenance Fees: Often $2.00–$5.00 per month (sometimes waived if you hold a large cash balance, which hurts your returns anyway).
- Investment Fees: Some providers charge an extra monthly fee just for the privilege of accessing mutual funds.
- Paper Statement Fees: An avoidable but annoying cost often charged by default.
The Fix: Shop around. Providers like Fidelity and Lively have moved the market by offering HSAs with no account minimums, no cash drag (you can invest the very first dollar), and zero maintenance fees. Do not settle for your employer’s default provider if their fees are high; you can often open your own secondary HSA and transfer funds into it.
Bonus Trap: The State Tax Surprise (CA & NJ)
The “triple tax advantage” is a federal rule. Most states play along, but two major states do not.
If you live in California or New Jersey, your HSA is not tax-free at the state level.
- Contributions: You must add your HSA contributions back to your income when filing state taxes.
- Earnings: You must report interest, dividends, and capital gains generated inside your HSA on your state tax return annually.
This adds a layer of record-keeping complexity that defeats the “set it and forget it” simplicity of the account. You essentially have to treat your HSA like a standard taxable brokerage account for state tax purposes.
Maximizing the HSA Despite the Flaws
Despite these hidden costs, the HSA remains a powerhouse for retirement planning—if you use it correctly. The key is to treat it as a specialized tool for healthcare costs rather than a generic savings account.
According to Fidelity’s 2025 Retiree Health Care Cost Estimate, a single 65-year-old retiring in 2025 may need approximately $172,500 to cover healthcare expenses in retirement. This massive liability makes the HSA indispensable.
Action Plan for 2025-2026
To get the most out of your HSA while dodging the costs above, follow this simple checklist:
- Max Out Contributions:
- 2025: $4,300 (Self) / $8,550 (Family)
- 2026: $4,400 (Self) / $8,750 (Family)
- Age 55+ Catch-up: Add $1,000 to the limits above.
- Review Your Provider: If you are paying monthly fees or have a cash minimum over $0, consider a “trustee-to-trustee” transfer to a low-cost provider like Fidelity.
- Spend It Down Later: If you are older, don’t hoard HSA cash significantly beyond what you might need for long-term care or out-of-pocket costs. Aim to deplete the account during your lifetime to avoid the beneficiary tax bomb.
- Watch the Calendar: Mark your 64th birthday on the calendar. That is your reminder to plan your HSA exit strategy before Medicare kicks in at 65.
FAQs About HSA Hidden Costs
Can I use my HSA to pay for Medicare premiums?
Yes. Once you turn 65, you can use HSA funds tax-free to pay for Medicare Part B, Part D, and Medicare Advantage premiums. However, you cannot use HSA funds to pay for Medigap (Medicare Supplement) premiums.
What happens if I accidentally contribute to my HSA while on Medicare?
You need to contact your HSA custodian immediately and ask for a “withdrawal of excess contributions” form. You must remove the excess money (and any earnings it generated) before the tax filing deadline to avoid the 6% excise penalty.
Is it better to leave my HSA to my spouse or my estate?
Leaving it to your spouse is far better. A spouse can assume the HSA as their own with no immediate tax liability. Leaving it to your estate or any non-spouse beneficiary triggers an immediate tax bill on the full balance.
Final Thoughts
The Health Savings Account is still one of the most powerful wealth-building tools available to Americans. No other account offers the triple tax advantage that can stretch your retirement dollars so far. However, it is not a “set it and forget it” vehicle.
By understanding the rules around Medicare, choosing the right beneficiary, and picking a low-fee provider, you can strip away the hidden costs and keep the benefits for yourself.
The information in this guide is meant for educational purposes. Your specific circumstances—including income, savings, health coverage, and goals—may require different approaches. When in doubt, consult a licensed professional.
Last updated: February 2026. Retirement benefits, tax laws, and healthcare costs change frequently—verify current details with official sources.
