What is an HSA? What you need to know about Health Savings Accounts
A health savings account is a great tool to use on your path to financial freedom. If you’re clever and plan ahead, it can act as a supplemental retirement account.
What is a health savings account?
A health savings account or an HSA is a type of bank account that helps you save for future medical expenses. You can contribute pre-tax dollars to your HSA. This can reduce your taxable income and save you money on taxes.
The purpose of the money in a health savings account is to help pay for qualified medical expenses. That’s the design of the account. Simple put. It’s a place to stash money that you plan to spend on health care.
Do I qualify for an HSA?
You are only allowed to open an HSA if you have a High Deductible Health Plan (HDHP). An HDPH generally has a higher yearly deductible than other health insurance plans. Hence the name, high deductible health plan. The basic advantages of an HDHP are a very low monthly premium and a max out-of-pocket limit per year. The target audience for a high deductible plan is low consumers of health care. Many preventative healthcare expenses are free with an HDHP.
You are also only allowed to contribute to an HSA if you have an active HDHP. Check your health insurance coverage each year before contributing money to your HSA. It’s really annoying to reverse over contributions.
How does a health savings account work?
An HSA functions like other bank accounts. They’re offered by banks or financial institutions. The standard account is a savings account that offers a low-interest rate. HSAs are now offering investing options. Which is great. This gives you the option to invest in stocks and bonds to help grow your money. Many banks require a cash balance minimum before you can invest money. For example bank of America requires $1000 before you can invest.
HSA accounts also track yearly contributions, withdrawals, and expenses. It’s common for HSA providers to give customers a debit card. Expenses on that debit card pull from the HSA cash balance. This eliminates the need for a receipt and reimbursing yourself. We’ll get into why that’s sub-optimal in a bit.
HSA Eligible Expenses
The purpose of the HSA is to help you save money for future healthcare expenses. The IRS calls these qualified medical expenses. The list can change each year if new rules are set by the IRS. It’s a clever habit to review the list each year when you’re doing your taxes.
If you’re like most humans you find the IRS website disenchanting. Check out this list from HSA Bank. It’s way more user-friendly and easier to read. For a comprehensive list of eligible HSA expenses visit hsalist.org. This website is a great resource for HSA account holders.
HSA Contribution Limits
Here are the annual contributions limits for your HSA set by IRS. This is for 2022
- $3,650 single coverage
- $7,300 family coverage
The IRS adjusts these numbers each year. Look for the new HSA contribution limits each year.
What happens to my health savings account when I change jobs
Step one, don’t panic. The money in your HSA is yours to keep if you change jobs. You’ll want to double-check on two common benefits provided by your employer if you change jobs.
The first is an employer contribution to your account. This is like a 401K matching contribution. The second is your employer paying the monthly account fee. It’s common for employers to pay this monthly fee on their behalf. So you may not know it exists until you leave or change jobs. If you’re paying a monthly fee, it’s wise to shop around to find a better account.
Lively is a great option and offers a free account to individuals. This platform provides investing options from TD Ameritrade. What I really like about Lively, there is no minimum balance required to invest! Now that’s a product feature I can get behind. Get that money invested and help it grow.
How to open an HSA
Typically if you sign up for an HDHP at work, your HR department will facilitate the opening of an HSA on your behalf.
This is great the first time you signup for an HDHP. But it can be annoying if your company switches insurance providers or if you change jobs. You can easily end up with several HSA accounts with different banks. Make sure you merge these accounts so you can stay on top of the contribution limits and all your money.
Here are a few options to check out if you’re looking to open an HSA account on your own.
Tax Advantages of an HSA
The triple tax savings of an HSA makes this account a solid pillar of your financial planning life. Here are the three benefits of putting money in your HSA.
- Pre-tax dollars
- Tax-free growth
- Tax-free withdrawals for qualified medical expenses
#1 – Pretax dollars are dollars that go directly from your employer into your HSA account. You do not pay taxes on these dollars earned. These dollars do not count towards your AGI. This means the dollars you contribute decrease your yearly tax liability. Gotta love that.
#2 – Tax-free growth. Since you know the power of compound growth and the value of investing in the stock market. It’s easy to arrive at a stock-heavy asset allocation. It’s reasonable to conclude an all-stock allocation makes the most sense. The compound growth from these investments is tax-free! Over many years your account will be multiples higher than the original principal. This is important since there are yearly contributions limits.
#3 – Tax-free withdrawals for qualified medical expenses. Money taken from the account to pay for medical expenses is not taxed. So no taxes going in, no taxes on the growth, and no taxes on the withdrawals. This is very similar to a ROTH IRA, and with rising taxes and healthcare costs on the horizon, it’s a valuable tool.
SMH Pro Strategy:
Many people use their HSA account as a temporary place to keep their money. They add a few hundred or thousands of dollars each year. Maybe their employer kicks them another 500 bucks each year. All good stuff. When medical expenses come up, they reach for their HSA debit card and tap their account to pay the bills. Totally logical, that’s the intended purpose of the account. But that strategy is sub-optimal.
The high achievers and financial freedom seekers use a different strategy. They invest their HSA money. They invest in equities and turn their money into capital. This simple strategy goes unused by 93% of Americans. According to this study, only 7% of people are investing their HSA funds By delaying the distribution of your HSA funds, you give it time to grow. Over 10, 20, or 30 years. Each dollar invested will be worth $2 to $10 if invested for long enough. Time in the market is a beautiful thing.
Max out contributions to your HSA each year. Invest your contributions to inequities and stay invested. Pay out-of-pocket for medical bills and do not withdraw money from your HSA. The true value of your HSA is to pay for future medical expenses decades from today.
How to use an HSA as a retirement account
Contribute to your HSA while you have an HDHP. These contributions are pre-tax dollars and help you lower your taxable income by the amount you contribute.
Invest your HSA money in low-cost index funds that track the stock market or S&P 500 index. Let this money compound and grow over many years.
Pay out-of-pocket for your medical expenses and save your receipts.
When you turn 65 withdraw the money needed to pay yourself back for all medical expenses. I hope you made digital copies of all those receipts! You can continue taking money out of your HSA for current or future medical expenses, all tax-free!
“Exceptions. There is no additional tax on distributions made after the date you are disabled, reach age 65, or die.” As stated by the IRS. I’m glad death is an exception to HSA taxes.
After the age of 65, you can also withdraw money from your HSA for nonmedical expenses, you just pay income tax. Just like you would with Traditional IRA withdrawals. Your HSA is now acting as a retirement account. Tax-free withdrawals for medical expenses, and tax as income withdrawals for everything else. Pretty clever high achiever, well done.
Health care is expensive and the average retiree is spending a lot of money on health care costs. As a FIRE advocate and conservative planner, I’m using my HSA account to fund retirement health costs. Full age retirement, not FIRE, so my HSA capital is for after I turn 65.
According to a recent study by RBC wealth management: a healthy 65-year-old retiree can expect to spend $404,253 on healthcare during retirement! That’s a big number and it doesn’t include long-term care costs. Long-term care adds another $100,000 per year on average!
I’ll show you the math I did for my personal HSA account.
- Annual contributions in today’s dollars and current limit: $3500
- Expected real return from investments: 5%
- Years until 65: 30
- Current balance: $43,000
- Expected Future Value in today’s dollars for my HSA at age 65: $419,285.90
As you can see I’m just barely on track to have enough money to fund the average cost of health care in retirement. That helps me feel a little better but it should scare you into action.
Firstly, I’ve already saved and invested over $40,000 in my HSA. And I’m also lucky to have 3 decades until full retirement age. With this incredible head start. I’m barely saving enough to pay for the average cost of health for a healthy person!
This math is why I continue to pay out-of-pocket for all medical expenses. Assuming contributions don’t increase in real dollars. The total contribution limit over 30 years is $105,000. The RBC data shows you need 4x that amount. This math screams invest in stocks! You need maximum return potential to grow your capital to $400,000.Spend your income on health care costs. Spend taxable savings from your emergency fund if needed. And let your HSA dollars snowball to 4x your original contributions. That’s the power of compound returns.
I hope you better understand the value of an HSA. And how to use it to build a more sound financial plan. Don’t let the unknown of an HSA or any financial products intimidated you. Everything is way more simple than it presents. Your smart, you can figure it all out. I’m sure of it. 🙂