To those who have access to them and the means to contribute, a Health Savings Account (HSA) can really feel more like a Hype Savings Account for your financial plan – if utilized well. We’ll break that hype down in this post…
What is a Health Savings Account?
An HSA is a specific type of account that allows people to save for medical expenses on a tax-advantaged basis. To open an HSA, the employee must be enrolled in a high deductible healthcare plan. That being the case, they’re not an option for everybody out there. Either way, it’s worth checking your benefits to see if it is something you’re able to take advantage of.
For those who may be more familiar with an FSA (Flexible Spending Account) – these are little different. FSAs are “use-it-or-lose-it” accounts, whereas the money that you put into an HSA rolls over from year to year. It stays in there until you decide to take it out.
A little on the landscape
Since first coming onto the scene in 2003, HSAs have continuously grown in popularity as more and more employers offer them – primarily larger companies. Nonetheless, the increase in availability of high deductible health plans – the prerequisite for having an HSA – doesn’t mean that everyone who has access is using the account. And that is ok on the one hand. Not everyone who can, necessarily should enroll in a high deductible plan and participate in an HSA. As with all areas of financial planning, individual circumstances will determine the best path to take. However, this 2022 report from Charles Schwab indicates that only about half of employees who are offered an HSA actually use it. So on the other hand, it does appear that there are a lot of missed opportunities out there.
Who might a high deductible health plan be good for?
Generally, the premiums for a HDHP will be lower than other health insurance plans, but they also tend to come with higher out-of-pocket expenses for medical care and – as the name implies – higher deductibles.
So who might be a good candidate for a HDHP? Well, all situations are unique, but if the following apply – you may be in a decent spot to give this option a hard look:
- You and your family are generally healthy and don’t require much medical attention
- You don’t take any or many expensive prescription medication
- You already have a solid Emergency Fund in place or are well on your way to getting there
- You have the available cash flow to contribute to an HSA
- Your employer makes sizeable HSA contributions on your behalf
- The thought of a higher deductible doesn’t cause you any anxiety
Even outside of the above bullet points, it’s worth it to sit down and do the math when comparing health insurance plans. Sometimes the tax savings (more on the tax benefits below) garnered from maxing out an HSA could be enough to offset the higher deductible and/or out-of-pocket max even if you experience healthcare costs during the year. I’ve also seen instances where just the employer’s contribution to an HSA is substantial enough to offset higher out-of-pocket costs that might otherwise be taken care of with a non-HDHP.
Plus there’s the long-term benefits that an HSA can provide… So, yes, there is a lot to account for when making a decision on HDHPs and HSAs.
The tax advantages of an HSA
This is where HSAs really shine. It’s the source of all the hype.
The Health Savings Account is the only vehicle out there with THREE tax perks:
- Contributions are made on a pre-tax basis (they can be deducted from income)
- Any growth in the account is not subject to tax (grows without the impact of taxation)
- Funds can be withdrawn from the account totally tax-free if they’re used for qualifying medical expenses
That’s right. By properly using this account, it’s possible to have a portion of your income be invested and then used for your benefit without ever being taxed. Pretty neat!
Tax warnings
Of course, there are some things to watch out for.
If you decide to withdraw money from an HSA and use it for anything other than a qualified medical expense – this amount will be included in your income for the year, making it taxable. Moreover, the IRS imposes an additional 20% penalty on that amount (unless you’re 65 or older – keep reading for more).
If you’re planning to itemize the cost of medical expenses when filing taxes, it is not possible to get a deduction for expenses that were covered with HSA funds. That’s because you already used “pre-tax” dollars to take care of that cost.
Some states have their own rules for the treatment of HSAs in regard to state income taxes. For example, California (my current state of residence) does not give a state tax deduction for contributions to a Health Savings Account. So it’s important to check the guidelines for where you live and consult with a tax professional.
Supercharging the HSA
The annual contribution limits for 2026 are:
- $4,400 for individual coverage
- $8,750 for family coverage
- Those age 55+ can contribute an additional $1,000
Note that those maximums include any amount an employer may contribute to the account.
Many people put money into an HSA and then use those dollars to pay for healthcare on an ongoing basis. This is a fine strategy. It allows you to use tax-free funds for those expenses. That’s a win. If you’re regularly withdrawing from the account to pay for medical costs, then it’s probably a good idea to simply leave the money in cash (uninvested).
However, it is also possible to invest the money within an HSA. And this is the great optimization feature of the HSA! Given the tax benefits and strength of compounding over several years, I will often recommend that clients treat this as another long-term, supplemental retirement account (assuming it makes sense in their situation).
Halfway through 2023, it was estimated that only 35% of all HSA assets were actually invested. There are probably several reasons for this, but I do believe a primary contributor is a lack of understanding on how HSAs can be used.
To set up your Health Savings Account for the greatest long-term success, it will involve paying for any medical expenses out of cash flow or other savings on hand. This frees up the HSA to be invested, without the expectation that any distributions will cut into its potential growth.
And let’s be real – it’s generally the case that healthcare expenses increase the older we get, and may be the highest during the later years of life in retirement. So the ability to build a bucket of funds in a tax-advantaged manner that will take care of these costs down the road is highly impactful. HSA dollars can even be used to pay for Medicare and long term care insurance premiums.
The kicker to using HSAs as long-term investment vehicles…? That 20% penalty mentioned above, when making a withdrawal for non-qualified expenses – it goes away at age 65. So if you’re a crazy lucky person who just doesn’t have any medical expenses later on in life, you can pull money out of an HSA for other needs without having to deal with that big slap on the wrist. You will have to pay taxes on the withdrawals, but keep in mind you’ll have benefited from the pre-tax contributions and tax-deferred growth. In essence, it gets the same treatment as a pre-tax Traditional IRA or 401k. The money can be used for whatever you want.
Furthermore, if you keep good records, you can reimburse qualifying healthcare expenses years down the road (it doesn’t have to be done right away or in the calendar year they were incurred). The only requirement is that the expense be one you picked up after establishing your HSA. So if you have a bill from your doctor’s office at age 34, you could choose to reimburse yourself from an HSA at age 80 if you wanted to (assuming you had the HSA prior to getting that bill). Again, it’s important to thoroughly track those medical costs and save receipts if you think you may reimburse them in the future.
Steps to optimize
So if you’re looking to make the most of your HSA, start with these steps:
- Contribute the annual maximum to the HSA
- Meet any required minimum cash balance (or keep an amount equal to your annual deductible in cash if you’d like an extra layer of security)
- Invest any dollars beyond the value needed for Step 2
- Track all contributions and healthcare expenses, and save receipts in case you decide to reimburse yourself one day – even several years down the road
Eddy Jurgielewicz, CFP® is a Partner and Lead Financial Planner at Upbeat Wealth, a fee-only firm based in New Orleans and serving clients virtually across the country. He specializes in providing straightforward financial guidance to ambitious young families as they navigate life’s many milestones.
Do you have questions about what we shared in this post, or anything else in general? Feel free to schedule a free consultation or drop us a line!
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