Maximizing Your HSA’s Full Potential: Stop Using It Like an Expense Account
Health Savings Accounts (HSAs) allow you to pay for a wide variety of qualifying healthcare expenses with pre-tax dollars. But this may not be the best use of your HSA funds (at least not now).
If you have the financial means to pay your healthcare costs directly, you might find greater value in treating your HSA as a long-term retirement savings tool rather than a healthcare checking account. This is particularly advantageous if you are younger, in relatively good health, and can afford to pay for minor medical expenses out of pocket. In the long run, it may be in your best interest to invest those HSA dollars for the long term, allowing the balance to grow and compound tax-free for use later in life or in an emergency.
First, the basics:
Who can fund an HSA?
HSAs can be funded by a variety of individuals, including the account holder and their employer. You must have a High Deductible Health Plan (HDHP) to be eligible to open or fund your HSA. If you’re not sure whether you qualify, check with your health insurance provider. Keep in mind that you may not be enrolled in any other non-HDHP health coverage (which includes Medicare) when you fund your HSA.
Once the funds are in your account, they’re yours to invest and use for life. Even if you lose your eligibility to contribute down the road because you change jobs or health plans, your HSA will follow you and may continue to grow and be utilized for qualifying medical expenses.
What’s so great about HSAs?
The triple tax advantage
These are the crown jewels of the HSA. It works like this:
Tax-Deductible Contributions: The money you put into your HSA reduces your taxable income for the year. You get a tax break, just for saving money and there’s no income limit.
Tax-Free Earnings: Any interest or capital gains within the HSA are tax-free, just like a 401k or IRA. There are typically a wide variety of investment options including stocks, bonds, ETFs, and mutual funds which can help you grow your savings.
Tax-Free Withdrawals: If the funds are used to pay for qualified medical expenses, distributions from your HSA are completely tax-free. This is similar to using funds from a Roth account, but it’s even better because you never paid taxes on your contributions in the first place.
Your Healthcare Emergency Fund
Your HSA functions as a healthcare emergency fund. Healthcare costs can be unpredictable, and by contributing regularly to your HSA, you create a financial safety net. If you’re young and healthy, odds are you won’t need to access these funds for medical expenses in the near term, but they will be there for you and your family in an emergency to help keep you out of costly debt.
Portability & Longevity
Unlike some other healthcare accounts, HSAs are entirely portable. Your HSA is yours to keep, even if you change jobs or insurance plans. It stays with you throughout your life. Given the high proportion of healthcare dollars that are spent in old age, odds are you or your spouse will utilize these funds tax-free for qualifying medical expenses during your lifetime.
Retirement Planning Flexibility
After age 65, you can withdraw funds from your HSA for any purpose without penalty (just pay ordinary income taxes, similar to a 401k or Traditional IRA, if they’re not used for qualifying medical expenses). While you would sacrifice a third piece of the triple tax advantage, this provides a great deal of flexibility should you not need your funds for medical care. Unused funds can be passed to your heirs and will be treated just like an inherited retirement account for tax purposes. But unlike retirement accounts, there are no RMDs (required minimum distributions).
Prioritizing regular contributions to your HSA can be an important part of your retirement savings plan. Funding your HSA actually falls near the top of our retirement savings waterfall, right after building up an emergency fund and before maxing out your Roth IRA.
Investing those HSA funds for the long run while paying minor healthcare expenses out of pocket can be a good strategic financial decision. By allowing your HSA to grow, you are maximizing the potential for tax-free earnings and distributions over your lifetime. The younger you are, the greater the compounded growth, resulting in a more substantial nest egg for future medical needs and added flexibility in your retirement plan.
