Here’s how to get the most out of your health savings account
A health savings account (HSA) gives you the opportunity to take advantage of certain tax advantages that no other account can touch. HSAs are referred to as triple tax advantaged accounts, and they are the only account that gets to carry around this title. But, what does triple tax advantaged mean exactly?
Triple Tax Advantage
Here are the three tax advantages of an HSA:
- Tax free contributions
Every dollar you contribute to your HSA reduces your taxable income.If you earn $100,000 this year and contribute $4,000 to your HSA, the actual income amount you’d show on your tax return drops to $96,000. It’s like that $4,000 you put in your HSA never existed from a tax perspective. This reduces the amount of FICA taxes you need to pay if this is taken straight out of your paycheck and it reduces your overall taxable income.This is similar to one benefit of something like a traditional 401(k) or IRA.
Where an HSA separates itself from a traditional retirement account comes from tax advantage number 2. - Tax free withdrawals
The money you withdraw from your HSA that is used for Qualified Medical Expenses (QME) is tax free. So, you’ve now avoided paying taxes on the money as it goes in as well as when the money comes out.There is a rather comprehensive list of what counts as a Qualified Medical Expense, and as we age, our medical costs tend to increase, making an HSA a great tool for funding your healthcare into the future. But, if these were the only two advantages of an HSA, we wouldn’t be nearly as excited about this account’s potential. - Tax free growth
The company that holds your HSA is called a custodian. Typically, HSA custodians have your money in some form of money market account that gets minimal interest. It’s not life changing, but it is growth on your money – that happens to be tax free. You do not pay any taxes on the interest your HSA accrues.But this is just the beginning of the growth opportunities of an HSA, and now we can cover the four HSA hacks that leverage these three tax advantages to give you an insane wealth opportunity.
HSA Hack #1 – Invest your HSA dollars
Many people don’t even know they can invest their HSA dollars! The vast majority of people who own an HSA do not invest their HSA dollars, and if this is you, you are missing out on an enormous opportunity.
Those HSA custodians – the company holding your HSA dollars like Health Equity, HSA Bank, Optum, Fidelity, and others – will have investment options for you to use. They typically have a few different investment funds from which you can choose to invest. These funds will vary based on your risk profile and how long you have to keep funds invested.
What difference does investing make versus just saving the dollars?
Check this out.
Erik the Saver vs Erik the Investor
Starting in 2024, Erik the saver maxes out his Family HSA every single year. He continues this discipline for 30 years. Like most people, he didn’t realize he could invest his HSA money, so he just left it in the savings account. For this example, let’s assume Erik and his family never have any healthcare expenses for 30 years (not realistic… we know… but go with us on this for a minute).
After 30 years, Erik the Saver’s HSA balance ends up at around $370,000.
And let’s take a moment to acknowledge how great that number actually is.
Now, let’s look at an alternate universe with Erik the Investor.
Erik the Investor found this article and made the same HSA contributions over the same 30 years, but he chose to invest those dollars instead of having them sit in a savings account getting next to no interest.
We’re going to give Erik the Investor an average of 7% growth over that time and, after 30 years, Erik the Investor’s HSA balance is about $900,000.
That’s $530,000 MORE than Erik the saver!
This doesn’t even count the catch up contributions Erik the Investor could take advantage of once he hits 55 years old. At 55 and older, you can actually contribute $1,000 MORE per year than the annual max. These big numbers I just gave don’t include those additional $1,000 per year contributions nor does it include that money’s growth.
So yes… investing your HSA dollars is a wealth hack that you should take a long, hard look at… however, this example has a glaring problem. How could anyone in their right mind possibly assume that a family isn’t going to have ANY healthcare expenses over 30 years?
And this is where HSA hack number 2 comes in.
HSA Hack #2 – Do Not Use Your HSA Dollars for Medical Expenses
You might be thinking to yourself, “This is financial blasphemy! Don’t use a health savings account for healthcare expenses?!”
We know it sounds crazy, but there is logic behind this.
Looking at the alternate-universe Eriks again, we now build in $2,000 per year of medical expenses for the families of both Eriks. After 30 years, Erik the Saver’s HSA is $60,000 less than it was in the previous scenario, and now only has $310,000 after 30 years. Which, let’s be honest with each other, this is still absolutely wonderful for a retiree.
However, there was a big missed opportunity.
Erik the Investor has the same scenario, $2,000 per year in medical costs, however, Erik the Investor approaches this differently. When he gets a qualified bill – like the $2,000 he had to pay for his daughter’s braces – instead of using his HSA money, he keeps that $2,000 invested in the HSA and pays for the braces out of pocket.
This leaves the HSA dollars alone and allows them to grow in the investments.
If we look at just that $2,000 – let’s pretend that was the first year, 2024 – invested with an average return of 7% over 30 years, and that $2,000 turns into over $15,000!
And, by not using the HSA for these expenses, and continuing to max his HSA contributions, after 30 years, Erik the Investor again has the $900,000 in his HSA rather than $60,000 less.
But things get even more interesting with hack number 3.
Before I get into hack number 3, we need to address something important in this exercise.
If you do not have the money to pay for medical expenses out of pocket, and you MUST use your HSA… do it!
There is a difference between the theoretical, most optimized strategies and real life.
Bad years happen. We lose jobs or go through tough times and just coming up with these dollars may not be realistic.
Practically, we maintain a balance of cash in our HSA at around $3,000 just incase something crazy happens, and we invest the rest. We know we’re missing out on some potential growth, but we’re okay with that security factor.
You can set up your own safeguards around what will make the most sense for you, but the more you can invest, the more potential for that money to work for you over time.
Okay, Hack number 3 feels like it is absolutely cheating, but it’s real, and here it is.
HSA Hack #3 – Reimburse Yourself for Historical Medical Expenses
An HSA gives you the opportunity to reimburse yourself for past medical expenses. And we’re not talking about recent expenses you may have had for a medical bill last week. We’re saying you can reimburse yourself for ANY medical expenses that happened at any time while you had your HSA. Yes… even years ago.
Piggybacking off of hack number 2, Erik the Investor paid $2,000 per year or $60,000 over 30 years out of pocket so he could let his HSA grow to $900,000. Guess what Erik the Investor can do that Erik the Saver could not now that they are say… 65 and Erik the Investor’s HSA balance is enormous?
Erik the Investor can reimburse himself for all of those $60,000 worth of expenses over the past 30 years… tax free. And now, he can use that $60,000 in retirement however he wants… tax free. And… even after all that reimbursement, he still has $840,000 in his HSA compared to the $310,000 of Erik the Saver.
That’s over half a million dollar improvement for Erik the Investor over Erik the Saver.
Now, you will need to properly document these payments over time with receipts, but that’s a significant difference in your wealth moving into the future.
Here’s a bonus hack for you related to documenting this expenses:
To help document the receipts over the course of your life, take a picture, and email it to yourself with the Subject line: Healthcare Expense + The Year it occurred.
You can also set up a specific email account for these healthcare receipts. Something like “FamilyNameHSA@Gmail.com.
Okay, we mentioned that the true triple tax advantages come from using HSA dollars for Qualified Medical Expenses, and these are important to understand before we can address hack number 4.
The list of qualified Medical expenses is massive, but it’s not unlimited.
Some that we found interesting were:
- An air conditioner with a letter of medical necessity.
- A swimming pool with a letter of medical necessity.
- Daith piercings – with a letter of medical necessity.
Daith piercings are when they pierce a part of the ear to relieve headaches.
You will want to make sure you are using HSA dollars for qualified medical expenses because if you use your HSA to pay for non-qualified expenses – like a swimming pool that is NOT medically necessary – you get double penalized.
The first penalty involves taxes. Any HSA money you used for non-qualified expenses will now become taxable income. The second penalty comes from the government. The government will assess you an additional 20% penalty for using your HSA incorrectly.
If you use $1,000 from your HSA for non-qualified expenses, and say you are at a 22% tax rate, you will have $220 to pay in taxes, plus another $200 to pay as the 20% penalty. So, 42% of the value of that withdrawal now goes to taxes and penalties.
Not good.
So, if you can help it, NEVER EVER USE HSA DOLLARS for non-qualified expenses… unless… here’s hack number 4.
HSA Hack #4 – After 65 Years Old, Use Your HSA For Whatever You Want
Once you reach 65 years old, you can now use your HSA dollars for anything you want!
The account essentially turns into a traditional IRA account of sorts where you can pull out the dollars for whatever you need, but you don’t have the Required Minimum Distributions to worry about like you would with a Traditional IRA.
Now… any money you use for things that are not qualified medical expenses will go towards your taxable income, but you won’t be penalized on top of that. And, once in retirement, there is a lot more flexibility (if you’ve planned correctly) to control your marginal and effective tax rates.
This means that Erik the Investor has over $500,000 more to use from 65+ for whatever he wants, with decent tax controls around his income.
Are HSAs Perfect?
No. They have some restrictions to work within, which we cover in another article, but, they are incredible wealth tools.
Now that you are an expert on HSAs, hopefully you can apply some of the tips we covered in this video to fully access that account’s power for you and your future.
If this was helpful for you, consider subscribing to our YouTube channel and our newsletter to learn more about making your retirement more comfortable.