The Health Savings Account (HSA) is one of the most advantageous, yet often overlooked, savings and investment accounts available. Today, we’ll demystify the HSA and discuss the trade-offs of using one.
The HSA was first introduced in 2004. Though only 11-12% of individuals have one, it has recently been getting a lot more attention. I only learned about the full benefits a few years ago. Part of the reason is that employers, justifiably, don’t heavily promote the benefits, yet that is the most likely place you’d first learn about the account.
Heads up, we are going to speak to some of its benefits, but this isn't a recommendation that an HSA is the right fit for you.
🧠 What you need to know
You may have also heard of flexible spending accounts (FSAs). Both FSA funds and HSA funds are tax-deductible and can be used for a variety of medical expenses. However, an FSA is a "use it or lose it" account, whereas HSA funds will always be yours and can do much more for you.
To contribute to an HSA, you must have a high-deductible health insurance plan that allows for HSA contributions. A high-deductible health plan isn’t for everyone, as you could be responsible for significant out-of-pocket medical expenses. While we won’t cover the insurance side of things today, one of the perks of a high-deductible plan can be a tax-free health savings account.
You would typically set up an HSA and manage contributions as part of your employer’s benefits process, similar to setting up a 401(k).
The annual HSA contribution limit for individuals is $3,850 and for families is $7,750, though these amounts often increase from year to year. Some employers may contribute to your HSA as part of their benefits package, similar to how they may contribute to your 401(k). If you are 55 or older, you can make an additional catch-up contribution of $1,000 per year.
The benefits
The tax deduction—reducing your taxable gross income—is great. But that’s only one benefit. Another, HSA funds can be invested in a variety of assets, like stocks, bonds, and ETFs, with appreciation growing tax free just like a 401(k) or IRA. The third tax benefit is that if you withdraw the funds for medical expenses, you won’t pay any tax either.
This triple tax advantage makes HSAs a powerful tool for saving and investing for both short-term medical costs and long-term financial goals.
Maximizing a single year's contribution to your HSA can result in significant growth over time. For example, let's say you try an HSA plan one year. If you contribute $3,850 just once and invest it with an average annual return of 7% (based on historical stock market returns), it could grow to approximately $29,853 over 30 years.
If you contribute the maximum every year (assuming the current individual limit of $3,850) and earn an average annual return of 7%, your HSA could grow to over $384,000 after 30 years.
If you’re particularly meticulous, you can save medical receipts from today and use HSA dollars for reimbursement even 30 years down the line (and beyond). If you are over 65 and don’t have enough medical needs to use your HSA funds, you can withdraw the money to enjoy retirement just like you would from an IRA or 401(k). Like those accounts, you would just need to pay taxes on distributions.
Investment options in HSAs
The name Health Savings Account is a bit confusing. Sometimes you’ll have separate savings and investment accounts. Other times they will be combined. For example, at one point I had a savings account with HSA Bank and a linked investment account with Devenir which only allowed me to invest in a select group of mutual funds.
I recently transferred everything to a combined Fidelity HSA brokerage account which allows me to invest in a variety of securities, such as stocks, bonds, mutual funds, and ETFs. More options offer the potential for higher returns, but also higher risk.
Major brokers like Schwab, Vanguard, and Fidelity offer HSA brokerage accounts.
⚠️ Watch out for these things
If you go down the HSA path, keep in mind a few things:
- Avoid exceeding contribution limits, as this could lead to unnecessary taxes and paperwork to rectify the situation
- Avoid using HSA funds for non-qualified medical expenses, which can result in penalties before age 65 and taxes.
- Watch out for high fees with some HSA administrators. These could include monthly admin fees, transfer fees, and minimum account balance fees.
🤝 How can Mezzi help?
It’s important to make sure your HSA investment account follows the right diversification and risk strategy for you, while optimizing allocations between taxable and tax-advantaged accounts. Mezzi can help you make the most of your HSA investments by providing insights and tools to optimize your portfolio:
- With Account tags, Mezzi makes it easy to track and compare HSA accounts with other tax-advantaged and taxable brokerage accounts.
- Allocation and concentration insights allow you to view all of your investment accounts as one portfolio, or your HSA account and other accounts separately.
- Easily track deposits across all of your accounts to make sure you are maximizing your opportunities to save.
- User Weekly and Monthly Rewinds to stay on top of your total portfolio performance.
