What is a Health Savings Account (HSA)

A health savings account (HSA) is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan (HDHP). These plans often make a lot of sense for younger people with infrequent medical visits. HSA funds can be used to pay for "qualified medical expenses" at any time without federal tax liability or penalty. Withdrawals for non-medical expenses are treated like IRAs. They provide tax advantages if taken after retirement age, and incur penalties if taken earlier.

For 2021, the HSA contribution limits have increased. An individual with self-only coverage under an HDHP can contribute up to $3,600, a $50 increase.  For those with family coverage, the new limit is $7,200, a $100 annual increase.

The key benefit of an HSA over other retirement savings vehicles

Triple tax savings.

Tax-free contributions

Keep more of your paycheck with pre-tax contributions. One of the benefits of an HSA is that no taxes are withheld from HSA contributions made through payroll deductions – so every dollar you contribute from your paycheck goes directly into your account. That means you could have more money to use on qualified health expenses than if you were to use funds from your checking or savings accounts.

Here’s an example of how tax-free contributions could give you more buying power when paying for qualified healthcare expenses when you contribute to an HSA.

Tax-free growth

Any interest or earnings on your account are tax free, which could add up to more dollars to use toward qualified health expenses. This is just one reason why utilizing the investing feature of your HSA account could be an important component of your long-term financial plan.

Tax-free withdrawals

When you contribute to a tax-advantaged account like a 401(k) or an IRA, you can expect to pay taxes on the money once you begin to make withdrawals. But that’s not the case with your HSA. You can make tax-free withdrawals from your account to pay for qualified health expenses.

How Does It Work

Depending on your health plan and provider, many HSAs allow for investing in individual stocks much like an IRA or brokerage account. HSAs often come with a debit card to use directly for medical expenses (co-pays, prescriptions, x-rays, etc). But the beauty of the HSA is that you don't NEED to take out the money NOW to pay for medical expenses. If you're able to, you can leave the money fully invested in stocks instead of carrying a cash balance. And you can pay with your own $ out of pocket, and keep the receipts. You can then "pay yourself back" at ANY time (even 30+ years down the road if you want) by simply claiming a withdrawal and taking cash out as long as you keep a good record of receipts.

After you reach age 65 or if you become disabled, you can withdraw HSA funds WITHOUT penalty but the amounts withdrawn will be taxable as ordinary income. So if you're lucky enough to stay healthy, you can now use the nest egg you built as an additional retirement source. That way, you can keep your HSA invested and leave it alone to grow tax-free. While the focus is on the IRA, the often misunderstood HSA can be just as powerful of an investment & retirement vehicle if used correctly due to its multiple tax advantages.

How it all adds up

Your HSA is yours for life—there is no use-it-or-lose-it rule, and the balance rolls over from year to year. With a careful balance of saving and spending, even with a modest rate of return on any investments, you have the opportunity to grow your account over time.

Smarter Planning. Smarter Portfolios. Smarter Fees.

CERTIFIED FINANCIAL PLANNER™