Reader Question: Should I Contribute to My Health Savings Account?

By Geoff Schaefer

Geoff is a Wealth Advisor with Intergy Private Wealth. He writes for The Steadfast Fiduciary to help people live with an abundant heart, open mind, and boundless generosity.

November 17, 2023

Health Insurance in America is not perfect.  I think everyone can agree on that.  It is a cost that, for the middle class especially, can be prohibitive and very expensive.  A partial solution to this over the past several years has been the High Deductible Health Plan (HDHP).  It has existed for a long time, but recently become an incredibly popular solution.  The high deductibles mean the insurance kicks in a bit later, but it can save a family a lot of money in premiums in a year that healthcare costs are low.  In reality if you compare a HDHP with a traditional health policy or HMO plan, the costs if you were to reach the out-of-pocket maxes are very similar.  I’m not going to dive into the nuance that is various health plans, rather highlight as specific part of the HDHP that is a planning powerhouse.

Ok Geoff, that’s a lot of hype for something, is it really that good?  The answer, yes.  The Health Savings Account (HSA) really is that good.

An HSA is a type of savings account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses. That means any money you put in the account, up to the annual limit, is deducted from your income as far as taxes are concerned.  You can then use these untaxed dollars in the HSA to pay for deductibles, copayments, coinsurance, and some other expenses, to lower your out-of-pocket health care costs. Things like glasses, over the counter medications, travel for medical care, home improvements for medical reasons, rehab programs and weigh loss programs are all examples of eligible expenses. But the deductibility of some medical expenses is not where the power of the HSA really lies.

Where the account really becomes interesting is that the balance rolls over from year to year.  So unused balances are combined with new contributions. This can take place year after year. Depending on where your HSA is custodied (Optum, HSA Bank, Fidelity, etc.) you can allocate the balance to stocks, bonds, CDs, and ETFs.  Any interest, dividends and capital gains from those investments grow in the account on a tax- deferred basis.  This is similar to 401(k) or Individual Retirement Account.  At any point in time, you can liquidate any of the balance for health care related expenses.

Health Care related withdrawals are ALWAYS 100% TAX FREE.  Say you contribute for 10 years, have over $70,000 in the account. In one year, you can take out $20,000 for medical expenses and the full investment gain is tax free.

So, there are THREE tax benefits of an HSA.

  1. Tax deductible contributions
  2. Tax deferred investment growth
  3. Tax free distributions for healthcare related expenses at any time

What happens if I don’t use the money for healthcare related expenses?  Good question. If you take the money out for non-healthcare related expenses, you’re subjected to tax on the withdrawal and a penalty.  However, after the age of 65, you can withdraw any amount and the penalty is waived. You only pay tax on the withdrawal, making this very similar to a pre-tax IRA or 401(k). 

My very practical question is, what happens around age 65?  Very simply, healthcare costs pick up.  Medicare premiums will begin. Many people are shopping for some sort of long-term care policy. Healthcare in general becomes more costly later in life. So practically, save the account for healthcare costs and use other retirement accounts for other expenses. Here’s an example of how an account could realistically grow over 20 years:

Contributing the 2024 family max of $8,300 every January for 20 years would have equaled $166,000 of contributions.  Using the Vanguard Wellesley Fund (a well know balanced fund- about 50% stocks and 50% bonds), you’d have grown your balance to over $310,000!! Almost a doubling of the account- all tax deferred!  In an all-stock portfolio, you’d be looking at a tax deferred balance of nearly $580,000!!

Piggybacking on that, there is one final kicker that makes this account awesome.  The only timing requirement regarding withdrawals is that they occur after the account has been opened.  So, you can track expenses for months, years, even decades and then take a fully qualified tax-free withdrawal down the road.

Pairing the growth example with the expense tracking example above.  Let’s say you opened a HSA January 1st of 2020 and started maxing out the account and tracking all the expenses you had.  From your $310,000 account, you could withdraw $133,425 in 2040 and pay no tax.  The withdrawal is a reimbursement of expenses after the account opening date and is all qualified and tax free! A really unique and powerful benefit.

I am fully aware that everyone will not be able to use the HSA in this capacity.  Life and healthcare can get expensive.  Raising children costs a lot of money and from time to time, you may have to dip into the HSA.  Some years, you may not be able to max out the account along with your IRA and 401(k). That is all ok and truly the reason why we plan. The examples I provided here are to show the uniqueness and power that is available with the Health Savings Account, not to broad brush recommend it.

HSAs are one of the best financial tools for managing healthcare expenses. They also provide a unique opportunity to add to your retirement savings or even save for other expenses. When managed properly, you can save on taxes now and down the road and provide flexibility within your retirement picture.

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