We all incur medical costs at one point or another. It may be simple purchases like bandages, or larger expenses like corrective eye surgery. For many Americans, paying out of pocket or running it through their insurance may be their primary method of paying. However, there is a way to save on some of these costs. In 2003, Congress passed the Medicare Prescription Drug, Improvement, and Modernization Act which created the Health Savings Account, or HSA.
These accounts were designed for consumers who have high deductible health plans (HDHP) to be able to save for upcoming medical expenses. However, HSAs have evolved from a place to save money for upcoming medical expenses to also being an account where you can grow your nest egg for retirement.
Select looks at how HSA’s work, and if it is the right type of account for you.
How does an HSA work?
A Health Savings Account is widely known as one of the best accounts to avoid taxes as it is known as having a “triple tax advantage”. Here’s how it works:
If you have a employer sponsored HSA, the funds you contribute go in pre-tax. If you deposit money that isn’t directly from your payroll, those funds are tax deductible. For 2022, the limit is $3,650 for single-insured, and $7,300 for families. If you are over 55 years old, each of those limits increase by $1,000. These limits are inclusive of any employer sponsored contributions.
If you elect to let the funds sit in the HSA to be used for qualified medical expenses, they will accumulate interest. However, interest rates tend to be incredibly low, so any earnings will be nominal. It is always recommended to invest the money inside an HSA, and if you need to access those funds for a medical bill, you can sell the investments.
If you have upcoming medical bills and know you will need the funds, all you need to do is submit the receipt to your HSA provider, and they will reimburse you for the cost.
The second tax advantage is that all growth of your HSA funds are tax free. For example, if you invest in an S&P 500 index fund and the funds grow in value, that growth is not taxable. Some HSA accounts require you must hold a certain amount in the HSA account outside of what you invest. For example, I had an HSA where I had to hold $2,000 in cash inside the HSA, and anything above that I was able to invest.
The third tax layer is that you can withdraw the funds from your HSA tax free for qualified medical expenses. But, there is one workaround if you don’t want to use the money for healthcare-related purposes: if you wait until age 65 you can withdraw funds for any reason. There are no penalty fees to do so, but the funds will be subject to income tax, similar to a traditional IRA.
Ideally, consumers will continue to deposit and invest money over time in a HSA as they would with any other retirement account, and once they turn 65, they can withdraw the money without being penalized.
Overall, the best use of an HSA is ideally to deposit funds, invest them and don’t touch them until you are 65. For example, if you deposited $100 per month for 30 years into an HSA and invested every dollar into an S&P 500 index fund, assuming an 8% return, you would have over $146,000 from a total investment of $36,000. But, if you need to use the funds for medical expenses, it’s a great way to set money away tax free.
If investing for retirement with tax benefits peaks your interest, you may consider opening a Roth IRA. This account is not attached to your employer or health insurance, but is a great vehicle to earn tax-free gains. Money goes in post-tax, and as long as you don’t touch the funds until you are 59 and a half years old, all gains and withdrawals are tax-fee.
With the same index fund strategy used in the HSA, you can quickly grow your retirement nest egg. Robo-advisors like Betterment and Wealthfront offer both IRAs and Roth IRAs: they can build you a portfolio (and rebalance it over time) based on your age, investment timeline and risk tolerance.
Is a HSA right for me?
A Health Savings Account is an excellent tool to not only save for upcoming health-related expenses, but also save for retirement. And regardless of employment status, you can open up a HSA today. However, there are several items to consider before beginning to invest in an HSA.
First, you must meet these requirements:
- Must be covered under a qualified high-deductible health plan (HDHP)
- May not be covered under any health plan that is not a qualified HDHP
- Must not be enrolled in Medicare (the healthcare component of the Social Security program)
- May not be claimed as a dependent on another individual’s tax return
If you meet these requirements, you are eligible to enroll in an HSA. But is the best fit for you?
Andrew Westlin, senior financial planner at Betterment, suggests that a certain type of consumer is more appropriate for an HSA. “If you are someone that goes to the doctor regularly and/or can’t afford to pay your deductible out of pocket, then a High Deductible Health Plan (and a HSA) is not right for you. But if you are healthy, don’t expect to have many medical expenses, and also have a safety net/could meet your deductible with cash on hand, then this type of plan may be a great fit,” he said.
For myself, I have a HSA through Lively as I have a HDHP and only visit the doctor once per year for preventative care. Each year, I try to meet the IRS maximum contribution for a single-coverage person. And every dollar I put away is invested within a brokerage account with TD Ameritrade.
Other HSA details
If you decide a HSA is right for you, here are a few things to consider:
- A health insurance plan is considered a HDHP if it meets the deductible standards determined by the IRS. You can find those here.
- Your HSA will provide you with a debit card to spend your HSA funds. Instead, you should use a rewards credit card for your medical expenses and collect rewards. I recently had corrective eye surgery, and all I needed to do was submit the receipt to my HSA provider, and they sent me the funds via direct deposit.
- If you have an employer-sponsored plan, your HSA dollars are yours to keep if you decide to leave your company. This is different than a flexible spending account (FSA), which is ‘use it or lose it’.
- If you decide to open your own HSA outside your employer, research what funds, stocks and bonds you’re able to invest in before picking a provider. Some providers have more to choose from than others.
- If you withdraw any funds and they are not used for a qualified medical expenses before 65, you will need to pay income tax and a 20% penalty.
- If you are choosing an HSA administrator for yourself, be sure to compare fee structures before you select an account. Many HSA accounts have fees attached to them, such as admin fees.
- If you have left your employer and want to switch HSA providers, you can move your funds from one account to another. There is typically a form to submit, and it may take a few weeks for the funds to transfer.
What to look for when selecting a HSA provider
Some of the most reputable health savings account providers are HealthSavings, Lively, The HSA Authority, and Fidelity. But which one is the best? When you are analyzing different providers, consider these major points:
- Investment options and strategy: If you plan on investing the money you deposit in an HSA, compare the investment options each platform gives you. Westlin suggests to always invest based on your goals. He says, “If you would intend to use your HSA as a savings account and withdraw from it to cover a medical expense, then you should invest in a lower-risk portfolio. Conversely, if you intend to use your HSA as a retirement account and keep money invested long-term, you can afford to take on more risk.”
- Fees: Like any retirement account, there are fees involved. When you are researching different accounts, be sure to look out for monthly account fees or investment fees.
- Debit card option: Like mentioned above, be sure to consider a cash-back or travel-rewards credit card for your qualifying medical expenses to earn rewards on your purchase. But if you prefer to use the funds directly in your HSA, see if the provider will issue a debit card.
- Account minimums: Some accounts require an account minimum before you can start investing. For example, The HSA Authority requires $1,000 in cash in your account before you can begin putting money in the market, and that $1,000 must always be present and not invested. So if you have $1,050 in your account, you may only invest $50.
Bottom line
If you have a HDHP, you should consider opening a Health Savings Account for its tax benefits and the opportunity to invest for the future. But, this account takes a bit more planning, as you have to look at your current health insurance and health situation.
Like Westlin recommended above, a HDHP is best for those who are generally healthy and have little to no medical expenses. So if a HDHP makes sense for you, a HSA may be a great tool to build wealth.