If you're contributing money to a health savings account (HSA), congratulations. You've made a smart financial choice by using an account that provides some of the most generous tax breaks available.
Unfortunately, many Americans who contribute to an HSA aren't taking full advantage of the major benefit this account has to offer. That's because very few people with an HSA are actually investing contributed funds, according to data from the Employee Benefit Research Institute (EBRI).
Not investing your HSA funds can be a big mistake
For those with qualifying high-deductible health insurance plans, HSAs allow contributions with pre-tax funds while money in the account can grow tax-free and be withdrawn tax-free as long as it's used for eligible medical expenses.
Unfortunately, according to EBRI, HSA owners almost always have their money in cash only. In fact, just 2% of accounts opened for only a year had investments other than cash. And while the dearth of investments in new accounts may be partly explained by the fact that HSA administrators sometimes require a minimum balance before the money can be invested, noncash investments are still present in just 17% of accounts open for 15 years or more.
To some extent, it's understandable if people don't put their HSA funds into the market if they plan to withdraw money soon for medical expenses and are worried about short-term market volatility. Money can be taken out of your HSA for healthcare at any time without a penalty or tax. But using your account this way means missing out on the major benefit it provides.
If you put money into an HSA and don't invest it, it's little more than a glorified savings account -- albeit one that lets you lower your out-of-pocket medical costs a bit by covering them with pre-tax dollars. But if you invest, you can (hopefully) substantially grow the value of the tax-deductible contributions you've made, pay no taxes on the gains, and withdraw the money later without owing income tax. No other investment account provides this triple tax benefit; traditional and Roth IRAs and 401(k)s requiring you to choose either pre-tax contributions or tax-free withdrawals.
And because HSAs aren't use-it-or-lose-it accounts, as flexible spending accounts are, you can leave your invested funds to grow for years and build a substantial nest egg. If you incur large healthcare costs in retirement, as many seniors do, you'll have a pool of tax-free funds to tap. You can also take money out for any purpose after age 65 and pay only ordinary income tax on it, so if you don't end up needing medical care, the money will still be accessible.
If you have very limited funds for medical care and expect to incur high medical expenses within the next five years or so, leaving HSA funds in cash may be your best bet so you don't risk investment losses on money you'll need soon.
But if you want to take full advantage of the generous tax savings only HSAs provide, join the minority of Americans who invest HSA funds. You could have plenty of money (and tax-free investment gains) to pay for healthcare costs later in life.