HSA's Are Called Health Savings Accounts, Not Health Spending Accounts, For a Reason

Simply put, I think Health Savings Accounts (HSA) are amazing. They give the trifecta of tax benefits, with tax-free contributions, tax-free growth, and tax-free distributions as long as money is going towards qualified health expenses. There is no other account that have triple tax-free benefits.  

HSA Basics:

First off, we need to take a quick step back and look at what Health Savings Accounts (HSA) are. These accounts are available to folks who are enrolled in a qualifying high deductible health insurance plan.  Obviously, high deductible health insurance plans are not right for a lot of people since the overall out of pocket medical expenses may be much higher if there are medical events.  That's where HSA's come in, HSA's provide an extra way for people with qualifying plans to save for those expenses.  

As mentioned before, when you contribute to the HSA account, you take a tax deduction in the year that you make that contribution. Most, if not all, HSA accounts give you options to invest your contributions for growth. You do not pay any taxes on any gains or earnings inside of the HSA account. You also owe no taxes on distributions from the HSA as long as you use the proceeds to purchase items from the broad list of qualifying medical expenses (see the full list of qualifying expenses the IRS publication here). There are penalties though on distributions for purposes other than medical expenses.  

Unlike Flexible Spending Accounts (FSA), Health Savings Accounts are not “use it or lose it,” meaning there is no requirement of when you have to use the money. You can even contribute and build up an HSA account during your working years and save it to use during your retirement years. For 2020 and 2021, those that qualify can (and should) contribute up to:

Making the most out of Health Savings Accounts:

Technically speaking, if you contribute to an HSA and immediately take the money out for a medical expense, you have saved yourself money by creating a tax deduction on your contribution and then immediately withdrawing the needed funds tax-free. In fact, this is pretty much what most people do. One HSA provider reported that in 2019, 96% of annual contributions were spent during the year on qualified medical expenses. Realistically that’s what these accounts were originally designed for, and if you are on a limited budget, that may be the best option. While this does save taxes, we can do better by keeping the account's money over a longer term.  

Tax-free growth is only helpful if we actually have growth. To do that, you need to emphasize the saving aspect by leaving money inside the HSA to invest over time. Yes, that means that if a medical expense comes up that you can afford to pay out of pocket, you pay it out of pocket. It also means spending some time looking at the options available inside the HSA and investing it for the future, just like you would in other types of accounts.  

By now, most people are conditioned that retirement accounts (401k’s, IRA’s, Roth IRA’s) are accounts to be used to save for retirement expenses. Similarly, I believe that HSA accounts are best used as a vehicle to save for future retirement healthcare expenses. You may read this and think, why would I try to keep as much as possible to grow an account that can only be used for medical expenses? As one gets older, medical expenses typically increase. The list of available qualified expenses is, in my opinion, pretty broad. Those over the age of 65 can even use HSA money to pay for Medicare Parts A, B, D, and HMO premiums. Unless you have significant assets in the HSA, which is hard to do given the contribution limits, I do not think you will find any shortages of uses for the money that qualifies for tax-free distributions.  

If you participate in a retirement plan, you are already saving for retirement expenses. HSA accounts are the most tax-efficient way to save for the medical segment of those retirement expenses. If you can use the HSA as a stealth retirement account, why wouldn’t you? 

Long-term HSA savings isn’t the best option for everyone. Budget, health, and risk tolerance factors play into if it is right for you. With the vast majority of Health Savings Accounts being used as a transactional account instead of savings, I am confident that many people are not using them in the best way. Don’t be one of them.  

_{This material is provided as a courtesy and for educational purposes only.  Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.}