The average retired couple aged 65 in 2021 will need roughly $300,000 to cover their out-of-pocket healthcare expenses in retirement. That's a big, budget-blowing number. Worse, the estimate does not account for long-term care, which can cost thousands per month.
A health savings account (HSA) can help you prepare for those costs, but there's a catch: It's probably not enough to just save -- you must invest those savings, too.
Unfortunately, many HSA account holders aren't using the investment features of their account. A report from Devenir Research concludes the average HSA investor has stashed away nearly $18,000, which is great. But the same report also finds 71% of HSA assets are uninvested, and less than 6% of HSA accounts invest their holdings. That will prove to be a costly mistake.
HSA, for now and later
Admittedly, an HSA isn't the easiest account to manage since you have competing priorities for those funds. Do you take tax-free HSA withdrawals now to cover current-year medical expenses, or do you leave funds in the account for your long-term healthcare needs?
There is a strong argument for earmarking most of those funds for the future. Let's run through some numbers:
- Say you have an HSA balance of $17,975 and you decide to invest 75% of the balance. You'd have about $4,495 in cash and invest $13,480.
- Invest $13,480 in equity index funds growing at 7% annually on average, and the balance would almost double in 10 years. You'd have an extra $13,000 on hand for your efforts.
Note that investing 75% of your HSA funds isn't the right strategy for everyone. If your current-year medical costs are low, you might invest more. And if you spend a lot on healthcare right now, you may invest less.
You can use a compound interest calculator like this one to understand how much you can make from your investments.
Minimum cash to invest
The process of investing your HSA funds is like investing in your 401(k), with one possible exception. Your HSA may require you reach a minimum cash balance before you invest, which is not necessary with a 401(k).
As with your typical 401(k), you choose your investments from a set menu of available funds. Once that's done and you fulfill the minimum balance requirement, your contributions going forward should be invested in your selected funds automatically.
How to pick HSA investments
Your risk tolerance, investment timeline, and wealth goals should influence your fund selections. Also, remember this basic rule: Equity funds produce higher returns than bond funds, but they come with more risk.
The 7% growth rate used in the example above implies an equity-heavy HSA portfolio -- 7% is the long-term average growth rate of the stock market after inflation. You could target that growth with an S&P 500 index fund, for example. That approach would be appropriate if you can handle some volatility, and you have 10 years or more between now and retirement.
If your timeline is shorter than 10 years, you might hold an S&P 500 index fund alongside a safer U.S. Treasuries fund. Your growth will be lower, but you won't see the balance fluctuate as much.
Build wealth in your HSA
The investment capabilities of your HSA are powerful. Use them to start building wealth for your senior years. A sizable balance that you can access tax-free for medical costs could be the surprise hero of your retirement plan.