HSAs are a tremendously powerful tool for accessing affordable health care, minimizing taxes, and even long-term wealth accumulation. There are multiple HSA strategies that help different kinds of taxpayers make the most of their health savings account.
Which HSA Strategy Is Right for You?
You can choose a more conservative approach, just taking advantage of the tax-free contributions and withdrawals for qualified medical and dental expenses.
Or you can use them more strategically, as a long-term investment and wealth-maximization tool, emphasizing the benefit of tax-deferral and treating your HSA as a retirement asset, much like a traditional IRA or 401(k)… but better.
Health Savings Accounts offer a powerful set of tax benefits: Tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified medical expenses (HealthCare.gov)
Here’s a closer look at each of these provisions:
Tax Deductible Contributions
Contributions to HSAs are made with non-taxable dollars.
They are either made pre-tax via an employer’s payroll deduction, or they are fully tax deductible, up to the annual contribution limit.
Also, HSA contributions are “above-the-line.” That means you can benefit from the tax deduction, even if you don’t itemize. Any American who qualifies to contribute to an HSA can benefit from contributing to an HSA.
Tax-Deferred Growth
Once the funds are inside the HSA, you can invest them in various financial instruments like stocks, bonds, mutual funds, or savings accounts.
The earnings and interest generated from these investments grow tax-deferred. This means that your HSA investments can appreciate over time without being subject to income, dividend, or capital gains taxes.
This means that your money can grow significantly faster than it can outside of a tax-advantaged account.
Tax-Free Withdrawals for Qualified Medical Expenses
Perhaps the most significant tax benefit is that withdrawals from an HSA for qualified medical expenses are entirely tax-free.
This includes expenses like doctor visits, prescriptions, hospital costs, and a wide range of other medical services. You can use your HSA funds to cover these expenses without incurring federal income taxes or additional penalties.
Additionally, HSAs can be a valuable tool for retirement planning, as after age 65, you can withdraw funds for any purpose without penalties (though non-medical withdrawals are subject to income tax).
There are no income limits or thresholds on HSA contributions, and no required minimum distributions on withdrawals.
Three Ways to Manage Your HSA
Whether you’re aiming for maximum growth or need a more budget-friendly approach, there are strategies to get the most out of your HSA. In this article, we’ll explore three distinct HSA strategies:
- A conservative approach for those who can’t afford to overfund their HSAs to surplus or who want to focus their accumulation efforts elsewhere;
- A middle-ground, moderate approach for those who have some capacity for funding their HSAs beyond short-term medical expenses, but who don’t want to take investment risk;
- A more aggressive, long-term strategy for those who want to maximize their HSAs as a long-term retirement asset, and who are willing to take on some investment risk in the interim.
Compare Pricing on the Best HSA Plans Available
1. Pay-As-You-Go: A Conservative Approach
This strategy is tailored for those who don’t have the means to contribute the maximum HSA limit each year:
Contribute just what you need to pay medical bills.
Here’s the beauty of this strategy: since you’ve deposited the exact amount of your medical expense into your HSA, you can later take that money back out tax-free. When you reimburse yourself for the medical expense, it’s considered a qualified HSA withdrawal, and it remains tax-free.
This approach allows you to make the most of your HSA even when you can’t afford to make significant contributions. It turns your out-of-pocket medical expenses into tax-efficient transactions by making the deposits tax-deductible and the withdrawals tax-free.
This approach avoids investment risk, but still captures the short-term tax advantages of tax-free contributions and tax-free distributions from HSAs.
With this approach, you would not make any contributions except for known or expected actual medical expenses for the current year.
How It Works
For example, suppose you have a $5,000 insurance deductible, and you’re in the 22% effective tax bracket.
You or someone in your family has an ER visit or hospitalization, and you incur much more than $5,000 in medical expenses.
In this case, if you were to pay the $5,000 deductible out of your own resources, without an HSA, you would have to earn $6,410.26 to have that $5,000 in hand to cover your deductible.
All you have to do is contribute $5,000 to your HSA either before or soon after incurring the expense, and either pay your providers directly with that money, or reimburse yourself.
Your net benefit from using an HSA rather than paying those costs out of your own checking or savings account is $1,410.26.
There’s no market risk involved at all: It’s entirely a tax arbitration strategy. You are simply paying your medical expenses with untaxed dollars rather than dollars taxed at 22%.
If you are in a state with a state income tax (other than California), or you are subject to Social Security tax withholding, the tax savings are even greater.
Again, there are no income limits or thresholds. Anyone who is covered under a high-deductible health plan and not otherwise disqualified because they have other health coverage can do this.
You can even do so in installments: Making contributions to your HSA over time, and then using the proceeds to pay your medical debts.
This strategy is accessible and beneficial even for those who can’t contribute the maximum to their HSA in any given year.
There is no downside to doing so.
This is one reason we are so strongly in favor of HSAs in general.
2. A Balanced, Low-Risk Approach: Maximize Tax Advantages With No Market Risk
With this strategy, you would contribute as much as you can to your HSA each year, up to the annual contribution limit.
The idea is to maximize your tax savings in the short run, and to use your HSA to pay medical expenses with tax-free dollars as necessary.
Meanwhile, you keep your HSA in an FDIC-guaranteed savings account, in cash. You won’t get a very high return on your HSA assets. But you’ll get something. And that accumulation in a tax-deferred HSA will probably be better than it would be in a taxable savings account or CD.
With this strategy, you get all the tax benefits of the HSA, but with no market risk.
Your HSA account will grow slowly and steadily until you need money for qualified medical expenses. However, if you’re in good health and don’t have significant medical expenses your balance should continue to accumulate year over year.
You don’t have to worry about market risk and being forced to liquidate assets at low prices in a bear market to pay for medical expenses.
As you approach retirement, your HSA can constitute a large cash allocation in your overall portfolio – enabling you to take on more risk elsewhere.
3. Maximum Growth Strategy: Turn Your HSA Into a Strategic Retirement Asset
This strategy is ideal for individuals with a high risk tolerance and a long-term view, aiming to accumulate wealth within their HSA over the long haul.
Maximize Contributions: Fund to the Fullest
The first step in the maximum growth strategy is to maximize your HSA contributions.
As of 2024, the annual HSA contribution limits are $4,150 for individuals and $8,300 for families.
Your goal is to contribute the maximum amount allowed by law to take full advantage of the tax benefits.
This can be effective because HSAs have even more favorable tax treatment of long-term growth than traditional IRAs and 401(k)s. So any wealth you can generate over and above your qualified medical expenses can compound that much faster.
Self-Directed HSA Investing
HSA assets aren’t limited to cash and cash equivalents.
Like IRAs and other tax-advantaged accounts, HSAs also support self-directed investing.
This means you can direct your HSA assets into other asset classes, as well, including mutual funds and EFTs, and even, theoretically, stocks, bonds, real estate, and other non-traditional assets.
This can be a great move if you have a long time horizon, you are in decent health, and you don’t expect to need much of your HSA money in the near future.
To take advantage of this strategy, you need to find an HSA custodian that supports self-directed investing.
There are dozens of banks and third party administrators who can help you do this. Their fee structures vary, and some will support more investment options than others.
But this can be a great way to get higher expected returns from your HSA assets over time.
However, investments carry risk. Stocks, bonds, mutual funds, and ETFs have no bank or FDIC guarantees.
You could potentially lose some or all of the money you invest. Read more about Turbocharge Your HSA: An Introduction to Self-Directed HSA Investing.
Q – Can I use self-directed HSA funds to invest in real estate or start a business?
While self-directed HSA funds can be used for various investments, it’s crucial to ensure that the investment complies with IRS regulations.
Investing in real estate or starting a business with HSA funds can be complicated, and you should consult with a tax professional for guidance.
How It Works
With this strategy, you should contribute as much as possible to your HSA.
The more you contribute, the more money there is to compound tax-deferred for as long as you leave the money in your account.
Once you have a few thousand dollars accumulated in your HSA, you then choose an HSA custodian that supports self-directed investments, and transfer your assets to that institution.
There are no taxes on direct trustee-to-trustee transfers to HSAs.
You can also transfer IRA assets directly to your HSA, tax free, on a limited basis.
You then select investments from the menu of options your HSA custodian offers, and direct them in writing to invest specific amounts of money in each of your choices.
Invest Aggressively: Embrace Tax-Deferred Growth
With a long-term investment horizon, you can allocate a significant portion of your HSA funds to investments with higher growth potential, such as stocks, mutual funds, or exchange-traded funds (ETFs).
This aggressive investment approach may generate higher returns over time. However, the more aggressive you are, the greater the volatility you can generally expect.
You should keep enough in cash or cash equivalents or relatively safe investments to pay for some short-term medical expenses, at least up to your plan’s out-of-pocket maximum for a year or two.
This way, if you have significant medical expenses during a down market, you won’t be forced to take a permanent hit by selling assets at fire sale prices to pay for medical expenses, the timing of which you cannot control.
Delay Withdrawals: Save Receipts for Future Tax-Free Withdrawals
A key element of this strategy is to avoid making withdrawals from your HSA for as long as possible, letting them compound for as long as possible.
Instead, save all your receipts and documentation for medical expenses, and pay them out of other funds that aren’t tax-advantaged. The funds invested in your HSA can continue to grow, unmolested by taxes, for many years.
When the time is right, you can reimburse yourself for these medical expenses – possibly when markets are high and you can get a good price for your assets in your self-directed HSA.
By contributing the maximum your budget allows, up to the annual limit, you will receive terrific tax savings in the short run.
And by holding off on withdrawals and letting your investments grow as long as possible, you can harness the power of tax-deferred growth.
At age 65, the usual 20% penalty on non-qualified withdrawals goes away. The funds then become available for any purpose. You just have to pay income taxes on any withdrawals, except for those required to pay qualified medical and dental expenses in retirement.
You can also use HSA funds to pay tax-free for long term care insurance premiums in retirement – another great reason to let your HSA funds accumulate.
Flexibility in the Future: Tax-Free Withdrawals
At any point in the future, you can access your HSA funds tax-free by using your saved receipts and documentation to reimburse yourself for qualified medical expenses.
This allows you to take advantage of the tax-deferred growth while still enjoying the tax benefits when you need the funds.
Compare Pricing on the Best HealthShare Plans Available
Conclusion
HSAs are versatile financial tools that can adapt to your financial situation and goals. Whether you’re pursuing aggressive growth or looking for a practical approach to managing your healthcare costs, there’s an HSA strategy for you.
With these strategies, your HSA becomes a valuable asset that aligns with your unique financial circumstances and objectives, providing tax benefits and financial flexibility.
For Further Reading : 2024 HSA Contribution Limits | HSA Questions and Answers | Which is Better, Health Sharing or Health Savings Accounts (HSA’s)? | Can I Use My HSA To Pay for a Service Dog? | Inherited Health Savings Accounts – What Happens to HSA Accounts When The Owner Dies?A Guide for HSA Beneficiaries
