As we head toward open enrollment season, this episode is dedicated to a deeper dive into Health Savings Accounts (or HSAs). As the title implies, this is one of our favorite financial accounts, and in this episode, we explain why. We start by outlining exactly what an HSA is, talk about the triple tax benefit of it, discuss the investment component of an HSA, touch on some of the different things you can spend HSA money on (including a surprising expense in retirement), then bring it all together by sharing some of the strategies around an HSA and how we prefer to use it within a financial plan.
Outline of this episode
- A quick overview of Health Savings Accounts (HSAs) [1:38]
- The tax benefits of Health Savings Accounts [4:42]
- Learn more about investing your HSA money [6:23]
- What counts as a qualifying expense? [8:05]
- How should you use your HSA dollars? [10:00]
- The recap [12:59]
A quick overview of Health Savings Accounts (HSA)
An HSA is an account that you - or your employer - can contribute money to. You can use it to pay for copays, deductibles, out-of-pocket healthcare expenses, and other qualifying expenses. Or, you can invest it and let it grow for the future, similar to a retirement account.
However, not everyone has access to an HSA. To qualify for an HSA, you must be part of a high-deductible insurance plan. What dollar amount qualifies as a high deductible? $1,500 for an individual and $3,000 for a family. Because of this, not every employer offers a high-deductible plan with an HSA. The HSA plan tends to have lower premium costs in exchange for the higher deductible.
Many employers that offer an HSA will contribute money to it each year (often $500–$1,000). This further reduces the cost of health insurance for the employee. HSAs have an annual contribution limit of $4,150 for an individual or $8,300 for families (in 2024). If you’re older than 55, you can contribute an additional $1,000 per year as a "catch up" contribution.
One of the best perks is that HSAs are not “use it or lose it” accounts. You don’t have to spend the money in the HSA in a set time period. It rolls over into the next year and grows tax-free (if invested). This flexibility is one of the many things that makes an HSA more attractive than a Flexible Spending Account (FSA).
The tax benefits of health savings accounts
An HSA is one of the only accounts that has a triple tax benefit. When you contribute money, you receive a tax deduction for each dollar you contribute. If you invest the money, it grows tax-free. Lastly, when you withdraw the money to spend it, you aren’t taxed on it.
The tax deduction is even more attractive than that of a 403b, 401k, or 457b. Each dollar you contribute is exempt from state and federal income tax. However, in addition, with an HSA each dollar contributed is also exempt from FICA taxes (i.e. Social Security and Medicare).
If you fall into the 32% federal tax bracket in Michigan, and you make the full $8,300 family contribution, you’ll save more than $3,000 in total taxes. You’ll receive a large tax deduction on the front end and later withdraw the money tax-free (as long as it’s spent on qualifying expenses).
How should you use your HSA dollars?
Most of us run into qualifying healthcare expenses every year. So does it make sense to use HSA dollars to cover those costs? It might - but we typically don’t recommend it. It’s not the financially optimal approach.
Instead, we prefer to cover out-of-pocket healthcare costs with cash flow and leave your money growing in your HSA. This maximizes the value of tax-free growth and tax-free withdrawals in retirement. That being said, if you can’t cover healthcare costs with current cash flow, you might have to pay for it with HSA money. But if you have the luxury of not needing it, it's good to let it grow.
If you can start contributing to an HSA relatively early in your career, and invest the money for the long-term, you could end up with another sizeable bucket of tax-advantaged dollars when you retire. This will help to fund your retirement lifestyle. Overall, an HSA is an extremely valuable tool to use as part of your overall financial plan.
Resources & People Mentioned
- Episode #25: Planning for Healthcare In Retirement
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup