Benjamin Franklin once said that "in this world, nothing can be certain, except death and taxes." However, our legendary founding father wasn't blessed with the type of financial sorcery that has spawned one of the most powerful savings accounts today, an account even more powerful than the 401(k) and the Roth IRA.
If Ben Franklin were as blessed as us, he might have revised his statement to remove taxes because this account completely avoids taxes: contributions are pre-tax, money that grows in the account doesn't get taxed, and withdrawals don't get taxed. (For all the cool kids out there, this is called triple tax advantaged.) It's the only account to avoid taxes like this and unbelievably, most people either don't know about it, don't use it, or - if they have money in it - don't invest the savings. Perhaps more unbelievably, the account is available to the rich and poor alike.
Of course I'm referring to the Health Savings Account, better known as an HSA, and it just might be the best tool in the personal finance toolkit. Primarily because of its tax advantages, the HSA a phenomenal way to significantly increase your wealth if used correctly. To provide a proper introduction of this wizardry, we'll go over the basics and then touch on how to get the most value out of the account.
What's the purpose of an HSA?
HSAs are special individual savings accounts (like the savings account at your bank) that are designed to help you save for medical expenses in a tax-efficient way. Unlike a Flexible Spending Account (i.e. FSA) in which if you don't use your money by the end of the year, you lose it, the money in an HSA stays there until you use it just like your bank account.
Who's eligible to open an HSA?
Only people who have a high-deductible health plan (HDHP) are eligible to open an account. Therefore, it tends to cater to younger generations. What does it mean to be in an HDHP?
The minimum deductible for your plan must be at least
How do I open an HSA?
Ideally, your employer has an HSA offering or partners with a 3rd party who offers one. In this case, check with your HR department for more info.
If this is not the case, fear not because you can open one on your own. However, make sure to choose an HSA that has no fees whether they be maintenance, opening, or closing fees and ensure that it offers investments in mutual funds. To find one that fits your needs, head to hsaseach.com and run a search. A simple search for HSAs that offers online access, investment options, and mutual fund access results in 42 providers.
While I can't provide many specific recommendations, my employer offers an HSA through HealthEquity and it's worked for me. I'm even provide with a debit card linked to my HSA so I can make payments on the fly. (Presumably, many HSA providers should have this feature.) In the end, they shouldn't be complicated, and as I'll explain in a moment, you shouldn't be using your HSA often, if at all.
What are the rules on withdrawals?
Unless your 65 or older, any money withdrawn from your HSA must be used for qualified medical expenses1. Surprisingly, the list of eligible expenses is quite extensive. (Someone once tipped me off to her #1 HSA tip: use them to buy prescription sunglasses. However, I also met someone recently who tried paying a cover charge at a bar with her HSA debit card. Definitely NOT allowed.2)
Another cool feature is that you can retroactively reimburse yourself for past medical expenses. So if you paid
Penalties
If you spend money on non-medical expenses, like, say, the cover charge at a bar, you will be subject to a 20% penalty on the withdrawal amount AND the withdraw will be considered taxable income.
How much can I contribute?
As of the 2022 tax year, individuals (including your employer) can contribute up to
How do I maximize the value of my HSA?
Okay so here's the thing: it's going to sound crazy, but the best way to maximize the value of your HSA is to treat it like it's a retirement account (401(k), Roth IRA, etc.). That is,
- Max it out
- Invest the money for the long term
- Don't touch it
Even though it's designed for medical expenses, the HSA should be treated as a form of long-term savings because having more money in an account that doesn't get taxed is a powerful wealth-building strategy. You can put more money in (because contributions are pre-tax), you can grow your money without worrying about the earnings being taxed, and any qualified withdrawals do not get included in income. Sadly, for people that are wise enough to have opened an account, they aren't taking the actions necessary to grow their wealth as evidenced by the statistics.
When it comes to determining how to invest, I would consider mirroring the stock/bond allocation you have in your retirement account. (If you don't know what allocation to choose, check out our prior newsletter.) Speaking to the far right infographic, leaving the money sitting in cash is not only silly because inflation is chomping away its value, but you're not taking advantage of two of the three tax-avoidance methods.
Of course, if you have to pull the money out for medical purposes, by all means do so. However, if you don't need to use your HSA, let it go and watch it grow! (I swear that rhyme wasn't intended, but I kind of like it.)
Notes
1If you're 65+, you can use your HSA for anything without penalty, not just medical expenses. However, non-qualified withdrawals are considered taxable income.
2Actually, this might be allowed if you can offset the withdrawal with a receipt for qualified medical expenses in the same amount. That is, you might be able to take out money from your HSA for non-medical expenses but you won't get the tax advantage unless you have a qualified medical expense in the same amount that you submit to your HSA provider.