Have you started investing in your Health Savings Account (HSA) yet? A common misunderstanding is that an HSA can only be used to pay for qualified health care, dental, and vision expenses. However, this is not the case as an HSA can be used for several different purposes. Therefore, if you want to learn more about what an HSA is, how it works, benefits of investing in an HSA, and action steps then you came to the right place.

Key Takeaways:

Health Savings Accounts and how to use them
The benefits of a triple tax-free retirement play
How to move your money from an HSA account for more investment options
What you can spend your money in the HSA account on
Why you need to look at the HSA as a long term investment strategy
Action steps you can take!

Health Savings Accounts and How to Use Them

An HSA is a type of savings account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses. These monies are untaxed dollars so you may be able to lower your overall health case costs. To be able to contribute to an HSA account you must have a high deductible health insurance plan which many people have been gravitating towards. The minimum annual deductible is $1,400 for self-only coverage and $2,800 for family coverage, with a maximum annual deductible and other out of pocket expenses of $7,000 per self and $14,000 per family for 2022. The annual inflation-adjusted limit on HSA contributions in 2022 is $3,650 for single filers and $7,300 for single or joint filers with children, with a consistent $1,000 catch up contribution for individuals ages 55 or older.

The best strategy is for both partners or spouses to have an account in their name and let me explain why. Say you and your spouse are both over the age of 55 with an HSA in the husband’s name. You would be able to make the $7,300 contribution for the year, but only he would be able to make the $1,000 catch up contribution. The wife would need an account in her name if she wanted to make a $1,000 catch up contribution as well so I recommend both spouses making an account from the start.

Another aspect of the HSA to consider is that the limit is a combination between what you and your employer put into the account. If you put $1,250 into the HSA and your employer contributed $2,400 then you have hit the limit and should not contribute any additional funds. Any funds contributed over the limit are not tax deductible and are generally subject to a 6% excise tax, so you must be aware of how much your employer is contributing. If you made a mistake and contributed over the limit, then you can avoid the penalties by filling out an HSA Distribution Request form and selecting Excess Contribution Removal as the reason. You will not be subject to the additional taxes if the excess amount (and any earning from the excess contributions) is removed before you file your personal income tax return for the year.

The Benefits of a Triple Tax-Free Retirement Play

The largest benefit of an HSA is that they are triple tax-free plans, meaning that you’re receiving a deduction when the money goes into the plan, then it grows tax deferred, and if you take it out for health-related costs then that’s also tax free. Compared to a Roth IRA where the growth is tax deferred and you have to ability to take it out tax free, but you don’t get a deduction when the money is contributed to the account. Therefore, the HSA is one of the best investment vehicles for those trying to save on taxes or fear that their healthcare costs will be too high in retirement.

You can (and should) invest the money in an HSA, however some providers significantly limit your options. The more limited plans will only allow you to invest in a money market fund that pays a low interest rate. If you find yourself in an HSA plan that pays little interest or has limited invested options and want to switch to another provider, then you do have the option to do so. You would want to target providers that include good investment choices such as a broad selection of low cost investment index funds with minimal fees.

Morningstar, an investment research company, provides a list each year of the best HSA accounts and the Fidelity HSA has been ranked number 1 for the past few years. They offer a spending account without maintenance fees, pay reasonable interest rates on deposits, eliminate or limit additional fees, and offer FDIC insurance on the spending account. I use a Fidelity HSA myself, and for those reasons I would recommend the Fidelity HSA to anyone who hasn’t opened one yet or is unhappy with their current provider.

How to Move Your Money from an HSA Account for more Investment Options

As mentioned above, there are plenty of reasons why someone would want to transfer their HSA to another custodian including poor or no investment choices, or that you need to build up a certain balance before you’re allowed to invest it. I have seen accounts that required individuals to reach a balance of $1,000 all the way up to $5,000 before they can invest the funds. Clearly, those plans are not the best, but there are people that stick with those custodians because they either don’t think they can transfer to another or simply don’t know how. Which is an issue considering the process is as simple as opening an account with a different custodian and transferring your current HSA balance into your new account.

Contributions to an HSA are typically made through payroll, however they don’t have to be. You could make contributions to reach the annual maximum until the tax filing deadline (April 15th). Therefore, it would be a good idea to max out your HSA contribution if haven’t yet and have cash available. If you already filed your taxes but believe making the contribution is worthwhile then you can amend your tax return to take advantage of this deduction assuming you qualify for it.

The IRS does require certain qualifications to be eligible for an HSA. First, you must be age 18 or older and cannot be a dependent on someone else’s tax return. In addition, you must be covered under a qualifying high-deductible health plan on the first day of the month with a minimum deductible of $1,400 for individuals and $2,800 for families. Those covered by TRICARE are disqualified from opening, making, or funding an HSA.

Lastly, individuals must cease HSA contributions at least 6 months before enrolling in Medicare. The consequence of not doing so is that you will receive a tax penalty on any money you contribute during the lookback period or while enrolled in Medicare. If you decide to work past 65 and remain on the company’s health plan, then you can continue to make contributions until you enroll in Medicare (6 months before retirement). Even enrolling in Medicare Part A will disqualify you from making an HSA contribution, but in some cases it would make sense if you have an injury or illness. You would be giving up HSA contributions for part of your hospital stay to be covered so again, for the right person it would be advantageous to do so.

What You Can Spend Your Money in the HSA Account On

The IRS has a list of all the things you can take money out of your HSA tax-free. A few of these items include doctors’ bills, surgeries, prescription drugs, but there are also things you wouldn’t expect like Band-Aids and Sunblock. You can also take money out of your HSA account to pay for health insurance premiums so when you become eligible for Medicare and get a Medicare Supplemental Plan, you could use the HSA to pay for those premiums. However, Medigap is not an eligible expense.

Even if you don’t have a lot of health related costs, an HSA account is still a valuable investment vehicle. First, you are going to have to pay for some of these health-related items at some point, so why not make the pre-tax contributions, let the money grow tax deferred, and pull it out tax-free. For the money that isn’t used to cover health-related costs, you can pull it out at age 65 or older and all you’ll have to do is pay income tax on it. Therefore, it would work just like a 401(k) in that you put the money in pre-tax and it grows tax-deferred.

The best way to utilize the HSA is contribute the maximum each year and allow the money to grow tax-deferred. Then you will want to keep track of any health costs you have out of pocket, either in excel or on paper. As these expenses build up, you now can take the money out tax-free at any point to reimburse yourself for these costs. If you have or spouse or dependents make sure to track their costs too. You should also hold onto the receipts from these services just in case you’re audited by the IRS. Let’s say you have $5,000 worth of health-related costs over the past year and you have $10,000 in your HSA, at any point you can take the money out tax-free to cover these.

Why You Need to Look at the HSA as a Long Term Investment Strategy

Many people don’t view these accounts as a long-term investing strategy, they put in the money and quickly spend it on their health related costs as they are incurred. You still get the benefit of the deduction and it’s coming out tax free, but the best part of the account is the ability for the money to accumulate and grow tax-deferred. The contributions are not large at $3,650 for a single participant or $7,300 for couples or anyone with a dependent, but over time those who contribute consistently and don’t touch the money often can grow these accounts to substantial amounts. I’ve seen this many times where clients have accumulated large HSAs and they can then use it as a tax-free income stream for health-related costs or another income stream, so HSAs are a long term investment play.

If you use the account as an investment play, then you probably want most of the money in stock index funds. These could include funds like a total stock market index fund or an S&P 500 index fund. You’d probably want to keep a portion of the money in cash or bonds to be available for you if you need the money sooner. If your health related expenses are larger one year, then expected then you want to make sure you have something liquid that you could sell to cover them.

If you remain relatively healthy then it could be a number of years until you’ll have to withdraw these funds from your HSA. Make sure to track your health-related costs so you know how much you could take out of the account to reimburse yourself tax-free. Now it does come down to your personal situation but having an HSA account and contributing the maximum each year seems to be a good approach for most.

Action Steps You Can Take!

The first thing that you should do is figure out if you eligible for a HSA, and if you are I would strongly recommend you open one up and start contributing to it. Remember, this is the only triple tax free account available so you should take advantage of that. If you already have an account, but it’s not earning much interest then I would recommend transferring it to another provider that pays more interest or offers you low-cost investment options like stock index funds. You’ll want to determine an asset allocation for this money that is right for you. The triple tax savings is great, but remember you need this money to keep pace with inflation which is why I recommend investing this money.

For saving towards retirement, the number one thing I would contribute to is your 401(k) to receive the maximum employer match. The employer match is free money that is going to grow tax deferred so that should be claimed first. The next thing I would do is contribute the maximum to your HSA because of all the benefits we have discussed. Lastly, I would go back to your 401(k) and contribute the maximum because like the HSA, that money is going to grow tax deferred.

These steps alone will not guarantee a comfortable retirement, but they are a step in the right direction. If you were unaware of the benefits of an HSA, then you are likely missing other “retirement hacks” that could have a large impact on your position in retirement. If you need help with your HSA or any other areas of financial planning, then take advantage of my free retirement planning assessment where we can dig deeper into your specific goals and needs.

How to Make the Most of Your Health Savings Account