The health savings account, or HSA, is not just a tax-advantaged way to budget for healthcare expenses – it is one of the most powerful and underappreciated financial tools that exist today. If you're eligible for an HSA, which requires being enrolled in a high-deductible health insurance plan, you should absolutely consider taking advantage of one. Here are three things that you need to keep in mind when deciding how to contribute to and spend money from your account.
1. Money can be carried over from year to year
Health savings accounts are often confused with flexible spending accounts (FSAs), but they aren't the same thing. The biggest difference is that while most of the money in an FSA needs to be spent before the end of the year, unused money in an HSA can be rolled over from year to year with no limitations.
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2. Money in an HSA can be invested
Despite the name, a health savings account isn't just a place to park money until you are ready to spend it on healthcare costs. While it can certainly be used in this way, money in a HSA can be invested. HSAs generally offer an assortment of investment funds, like what you'd find in a 401(k).
This means that if you contribute more money to your health savings account than you end up using to pay for healthcare expenses, anything that remains can be invested to generate returns over time.
Think of it this way. Let's say that you have family health coverage that qualifies for a health savings account, and you put $5,000 per year into it starting when you're 40 years old. You never actually use the money to pay for healthcare, and your investments return 7% per year on average. By the time you're 65, you'd have more than $343,000 in your account that could be used to cover healthcare expenses in retirement. Fidelity estimates that the average retired couple will spend $315,000 on healthcare in retirement, so this can be a great way to plan for these costs.
3. HSAs have a rare triple tax advantage
Because money can be carried over from year to year and will (hopefully) earn investment returns in the process, it's important to realize that HSAs get a triple tax advantage that is unique.
First, your contributions to an HSA are tax deductible in the year when they're made. For 2023, you can contribute as much as $3,850 to your health savings account if you have single health coverage or $7,750 if you have family coverage.
Second, your investments are free to grow and compound on a tax-free basis. You won't get a bill for capital gains or dividends each year, for example. So far, these first two characteristics are the same as you'd get with a traditional IRA or 401(k).
Third, any withdrawals made for qualified healthcare expenses are 100% tax-free. The combination of tax-deductible contributions and tax-free withdrawals is a unique benefit and can be very valuable, especially if you leave the money in your HSA to compound for years.
4. Your HSA can supplement your retirement savings
One of the most interesting features of a health savings account is that the money in your account can be used for any reason after you turn 65 – not just for healthcare expenses. To be sure, withdrawals for non-healthcare reasons won't be tax-free. Rather, they will be treated as ordinary income, similar to withdrawals from a traditional IRA or 401(k). This makes an HSA a great way to budget for healthcare expenses, but whatever you don't need to spend on healthcare can become a big supplement to your retirement nest egg.
A valuable financial tool
As you can see, an HSA can be an extremely valuable financial tool for planning healthcare expenses and for retirement in general. If you are eligible to contribute to an HSA, it's a good idea to strongly consider doing so and to take advantage of all of these benefits it has to offer.
