Five Key Points
- Triple Tax Advantage – Pretax contributions, tax-free growth, and tax-free qualified withdrawals.
- No "Use-It-or-Lose-It" Rule – Funds roll over indefinitely, unlike FSAs.
- Employer Contributions Count – If your employer contributes, this counts towards the annual limit.
- Penalty-Free After Age 65 – Non-medical withdrawals are treated like traditional IRA withdrawals (taxed but penalty-free).
- Long-Term Investment Potential – HSAs can serve as a retirement vehicle, particularly for future medical costs.
The Amazing Financial Vehicle – The HSA (or the little engine that could)
Health Savings Accounts (HSAs) are amazing, possibly the best financial vehicles for building wealth. In this article, we explain why you should maximize your contributions to an HSA and pay for most, if not all, of your medical expenses out of pocket. We also compare an HSA to the more widely available Flexible Spending Account (FSA), where, unlike the HSA, if you don’t use your contributions each year, your money is forfeited.
Why HSAs Are Often Overlooked
HSAs have been around for a while. I still get quite a few questions about these amazing financial vehicles. I think this is for two main reasons. First, not everyone has access to an HSA. You can set up an HSA only if your employer offers a high-deductible health insurance plan (HDHP). If you have an HDHP option available, we get to the second reason: the very name of the plan – high deductible health care plan. High and deductible are not words people like to hear together, and this scares people off before they learn more. In this case, they should learn more.
Note: For 2024, a high-deductible plan is defined as having a deductible of at least $1,650 for an individual or $3,300 for a family. [Source: IRS Publication 969]
HSAs vs. FSAs
Most people are aware that HSAs, like the more widely available Flexible Spending Accounts (FSAs), are used to pay for medical expenses. Both types of accounts are funded with pre-tax contributions that can then be used to pay for out-of-pocket medical expenses. Tax savings are why both accounts exist, but you can only have one of the two.
The key difference? FSA contributions must be used within the plan year (or by April 15th of the following year, depending on your employer's plan), or the amount is forfeited. Forfeited funds within an FSA go back to your employer.
The Power of the HSA
Contributions to an HSA, however, are not forfeited at the end of the year. Instead, contributions (up to $4,150 for an individual and $8,300 for a family in 2024) can be invested and used later, potentially many years later. [Source: IRS Publication 969] The HSA custodian determines which funds are offered within the HSA, but much like 401(k)s, these fund options continue to get better with more choices and lower fees. This means not only are contributions tax-free, but so too are any investment gains within the account. Many employers will even contribute some funds to your HSA on your behalf.
Like a traditional IRA or 401(k), contributions to an HSA are not taxed in the year they are made. But unlike IRAs or 401(k)s, withdrawals from HSAs are also not taxed if used for qualified medical expenses. This makes them a powerful triple tax-advantaged tool:
- Tax-deductible contributions: Reduce your taxable income.
- Tax-free growth: Investment earnings grow tax-free.
- Tax-free withdrawals: No taxes on withdrawals for qualified medical expenses.
Even if you rarely have medical expenses, you can still withdraw the money after age 65 for any reason without penalty. You'll pay income tax on the withdrawal, similar to a traditional 401(k) or IRA, but avoid the 20% penalty for early withdrawals.
Example: Growing Wealth with an HSA
The HSA is especially powerful for young investors. For example, let's say Addy, who is 24 years old, invests the maximum amount in her HSA ($4,150/year, adjusted for inflation) until she is 35 and then stops. Assuming a rate of return of 7%, her balance will grow to over $450,000 by the time she is 60. She will then have this money to pay for medical bills with no tax implications.
Dealing with Current Medical Bills
Ideally, you would pay for medical expenses out of pocket and let your HSA funds grow tax-free. However, this isn't always feasible. One strategy is to set a threshold (e.g., $500) and only submit bills for reimbursement through the HSA if they exceed that amount.
Risks and Considerations
One risk is that some employer-sponsored plans may have limited investment options or higher fees than you'd find elsewhere. However, you can usually roll over your HSA to another provider with lower-cost funds and more investment choices, even while you're still working for the same employer. This allows you to maintain the tax advantages of your HSA while optimizing your investment strategy.
Perhaps the most significant risk with an HSA is the temptation to withdraw funds for non-medical expenses before age 65. Remember, if you withdraw funds for non-qualified expenses before 65, you'll incur income tax plus a 20% penalty. This can significantly derail your long-term savings goals.
It's important to strike a balance between maximizing the long-term benefits of your HSA and managing current healthcare costs. While ideally, you'd pay all medical expenses out-of-pocket to allow your HSA funds to grow tax-free, there may be instances where a large medical bill could strain your finances and interfere with other financial goals. In these situations, it might make sense to use your HSA funds, but do so strategically and consider the potential impact on your long-term savings.
Value of the HSA as a Retirement Vehicle
HSAs are incredible wealth-building tools that should be considered by every investor who has access to one, especially younger investors. Their flexibility and tax advantages make them invaluable for both traditional and early retirement.
Schedule a Call
Ready to unlock the full potential of an HSA? Don't miss out on this powerful financial tool. Schedule a free consultation today, and let's discuss how an HSA can help you achieve your financial goals.
FAQ
Q: Who qualifies for an HSA?
A: Only individuals enrolled in a high-deductible health plan (HDHP) can open an HSA.
Q: Is it better to use HSA funds immediately or let them grow?
A: If you can afford it, letting HSA funds grow tax-free is generally better for long-term financial health.
Q: Can HSA funds be used for non-medical expenses?
A: Before age 65, non-medical withdrawals incur a 20% penalty and are subject to income tax. After 65, these withdrawals are taxed as ordinary income but without penalties.
Q: Can I transfer my HSA funds?
A: Yes, HSAs are portable and can be transferred to different providers when changing jobs or as desired.
Final Thoughts
HSAs offer a unique combination of tax advantages and long-term growth potential. Whether you're looking to reduce your current tax burden, save for future medical expenses, or boost your retirement savings, an HSA can be a valuable asset.
Take control of your financial future—schedule a call today.
About the Author
Sean Lovison, CPA, CFP®, is a flat fee-only financial planner based in Moorestown, New Jersey, serving clients virtually nationwide. After spending 14 years as a corporate chief financial officer (CFO), receiving and designing compensation plans, he decided to help others navigate their plans.
All written content on this site is for information purposes only. Opinions expressed herein are solely those of Sean Lovison and Purpose Built (PB), unless otherwise specifically cited. The material presented is believed to be from reliable sources, and no representations are made by our firm regarding other parties' informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant, or legal counsel prior to implementation.
The information on this site is provided "AS IS" and without warranties of any kind, either express or implied. To the fullest extent permissible pursuant to applicable laws, PB disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose. PB does not warrant that the information will be free from error. None of the information provided on this website is intended as investment, tax, accounting, or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. Under no circumstances shall PB be liable for any direct, indirect, special, or consequential damages that result from the use of, or the inability to use, the materials on this site, even if PB or a PB-authorized representative has been advised of the possibility of such damages. In no event shall Purpose Built have any liability to you for damages, losses, and causes of action for accessing this site. Information on this website should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized.
.jpg)
