By Dr. James M. Dahle, WCI Founder
Health Savings Accounts (HSAs) were established with the Medicare Prescription Drug, Improvement, and Modernization Act signed into law at the end of 2003. These accounts are a dramatic improvement over the older Medical Savings Accounts (which were limited to the self-employed and small businesses), Health Reimbursement Arrangements (where the employer owns the account), and Flexible Spending Accounts (which are “use-lose” accounts that do not roll over year to year). Many investors do not realize that an HSA is, in many ways, their best investing account. It is particularly useful for high-income professionals.
7 Reasons a Health Savings Account (HSA) Should Be Your Favorite Account
#1 A Healthy Family
If none of the members of your family suffer from an expensive, chronic medical condition, chances are good that a High-Deductible Health Insurance Plan (HDHP) is the right plan for you due to its lower premiums. In order to have an HSA, you must only be covered under an HDHP. You cannot be covered under another health insurance plan or a health-sharing plan.
In 2019, an individual covered only by an HDHP may contribute $3,500 ($3,550 in 2020) to an HSA. A family (defined as two members, not necessarily both spouses) may contribute $7,000 ($7,100 in 2020). If one member of the family is 55 or older, there is an additional $1,000 “catch-up” contribution permitted. Note that contributions for 2019 can still be made until April 15th, 2020.
#2 A High Income
HSAs are particularly useful for high-income professionals for several reasons:
- They are likely to have the discretionary income to actually make a contribution to the HSA each year.
- They are often able to cash flow the deductibles and co-pays related to their health care expenses.
- Finally, and most importantly, they benefit the most from making the contributions due to their high marginal tax rates.
When a family contributes $7,000 to an HSA, that money is no longer subject to federal or state income taxes. If your combined marginal tax rate is 45%, that deduction is the equivalent of receiving a gift for $3,150 for your birthday, to spend on whatever you like. In addition, if the contributions are taken out of your paycheck by your employer, they are not subject to payroll taxes like Social Security and Medicare either.
#3 Ability to Invest
A lot of people do not realize they can invest their HSAs. Perhaps this is because the default option is usually a low-yield savings account. However, just like a 401(k) or Roth IRA, money in an HSA can be invested in mutual funds such as broadly diversified, low-cost index mutual funds. If the HSA selected by your employer does not permit mutual fund investing, you can rollover your HSA dollars to one that does allow it once per year. In fact, you never have to use the HSA selected by your employer, although you will give up a possible payroll tax deduction if you do not. This permits the HSA to earn a higher rate of return, and the fact that HSA dollars roll over year to year, allows you to invest for the long term. Just like a 401(k) or a Roth IRA, an HSA also shields your investment return from the tax drag of long-term capital gains and dividend-related taxes.
#4 Tax-Free Withdrawals
Withdrawals from an HSA are tax-free so long as they are used to pay for health care expenses (including Medicare premiums). If used this way, HSA dollars are “triple-tax-free”, since you received a deduction when you contributed them, they were sheltered from taxation while they grew in the account, and they were withdrawn tax-free. An HSA is the only triple-tax-free investing account available to you, so in this respect, it is your best investing account. While HSA dollars can be used for ongoing health care expenses, the account really shines when used to pay for health care expenses decades from now, after the money has had time for compound interest to work its magic on it.
#5 A Stealth IRA
Some people worry about contributing too much to an HSA because they worry they will not be able to spend it all on health care. However, this fear comes from a misunderstanding of HSA rules. Once you turn 65, you can make withdrawals from your HSA and spend the money on anything you like without having to pay the normal 20% penalty. You will have to pay taxes at your ordinary marginal income tax rate, of course. However, in this respect, an HSA is no different from your 401(k). It is still “double-tax-free,” and thus functions as a “stealth IRA.” While it is always better to spend HSA dollars on health care, you should have no fear of overfunding the account.
#6 The Saving Receipts Strategy
While HSA dollars must be spent on health care in order to be withdrawn tax-free, there is no requirement under current law that the withdrawals be taken in the same year the health care is purchased. Thus, some investors have elected to save their receipts to allow for future tax-free withdrawals from the account. This introduces a major hassle of having to keep track of the receipts in the event of an audit, and the receipts are not adjusted upward for inflation. There is also some legislative/regulatory risk there that the rules could be changed in the future. That hassle and risk must be weighed against the benefit of ongoing tax drag protection to make the right decision for you.
#7 Mandatory Spending
HSA dollars are best spent by the contributor and spouse during life as the HSA rules do not provide significant estate planning benefits. If inherited by your spouse, the account remains an HSA. If inherited by anyone else, every dollar in the HSA becomes fully taxable income to your heir in the year of your death.
Unlike most retirement accounts, HSAs do not enjoy particularly robust asset protection benefits. Although case law is far from settled, HSA dollars are generally included in your bankruptcy estate. A few states, however, do provide an exemption for HSAs. Hopefully, that list will continue to grow.
Since the estate planning and asset protection benefits of HSAs are weak, these accounts are best spent during your lifetime. Given the rapid rise in health care costs, that should not be too difficult for most.
In many respects, Health Savings Accounts are the best investment account available to an investor and perhaps the first place to invest each year. HSAs have superior tax protection features compared to any other investment account including their “triple-tax-free” nature, the ability to withdraw the money after 65 for any purpose penalty-free, and the ability to delay withdrawals while saving receipts. If you are using an HDHP, be sure to take advantage of investing in an HSA.
Do you use a Health Savings Account to pay for health care costs? Do you also use the HSA as an investment account? Do you save receipts for future withdrawals? Why or why not? Comment below!
If you are covered under your spouse’s insurance (TRICARE, military) then can you still contribute to your employer’s (non-military) HSA? If not, what similar options are there?
From what I understand , No. You cannot be covered by any other insurance (including Tricare) if you want to contribute to HSA. You might be able to have a Flexible Spending Account or FSA ,but the money in it doesn’t roll over year to year. So if you know you will have fixed medical expenses in the coming year, you can contribute those dollars tax free to FSA and then pay medical bills with it. Be sure to use it all before December 31st of the year, or you will lose it.
No. If you use your employer’s insurance instead of TRICARE then you can contribute for you, but I wouldn’t do that if I were you.
My employer just opened an HSA this year and there was a lot of debate about whether to use it or not. I had the same conversation about 20 times during open enrollment. The issue was two things:
1) The premium was not that much cheaper for our HDHP compared to the other option. And so, people didn’t really see it as saving them a lot of money if “nothing” happened that year.
2) People kept looking at the decision “in a vaccum” for the one year instead of over a five or ten year period and the odds of having a lot of medical expenses during that time. If you put in $70k into an HSA over ten years and only use $35K, you still made out like a bandit. In a single year, it might not be the right choice depending on what happens.
3) Many people don’t like to self-insure and would rather know exactly what they have to pay each time they go to get medical care. This is a personal “Risk tolerance” issue.
Personally, I still opened up the HSA and plan to fully fund it every year that it is available with the long term horizon in view.
TPP
Yes! Although, the option to invest was just offered this year. So…timely article, because making an investment selection is already on today’s “To Do” list.
Nonsense. You can do a rollover out of your employer’s chosen HSA to your own chosen HSA once a year. You could have been investing for years, just with a bit of a delay.
You can also use the HSA to pay Medicare premiums so that’s a potentially huge future expense that you wouldn’t have to worry about. Fortunately my HSA has a S&P index fund so I didn’t have to mess around with shopping for a new account.
The HSA is by far my favorite tax deferred account I have available. I am lucky that my HSA company does allow investing option (they charge $3/mo regardless of balance).
I have always cash flowed my medical expenses to protect my HSA value which continues to grow over the years.
I know people complain that they have to save every single medical receipt to claim later (I do keep receipts myself), but I really feel that even if you do not keep a single receipt, the amount of medical expenses you are likely to incur when retired should more than be enough to take out all if not the majority of your HSA balance (studies show that the average 65 yo couple will have over $250k of medical expenses in their lifetime). The way Healthcare is trending, this is likely going to outpace the growth of any HSA by a Longshot. As you mentioned, the balance from the HSA not medically used will come out just like a normal retirement fund anyway.
An easy way to save your receipts is ask your Medical carrier to send you a download of EOBs (explanation of benefits) for the year. This won’t capture every band aid and sunblock purchase but any billable doctor visit. Then you have 1 electronic file per year. They may be able to back several years depending on how long you’ve had coverage.
Good idea.
I just started maxing out my HSA in the past two years, thinking of it AFTER the 5% salary deduction 401A (with 5% match), 457 plan ($25,000), and SEP-IRA (side gig $30,000). The company puts $2000 in the HSA, so I can put another $5000.
Maxing all of these puts about $75,000 off the top plus the company contribution on the 401A and HSA. I wouldn’t be able to top them all off without my “second job”.
I’ll have to check today and see if the HSA has an investment option. We seem to spend most of it on meds, copays, and uncompensated medical bills to the tune of $4000 a year…and none of us are sick. As you said, I mostly leave it there and pay most of this with cash.
What exactly is involved in obtaining reimbursement for healthcare expenses in a delayed fashion? Is this simply done online, emailing a scanned receipt? Do you have to speak to someone on the phone? Mail something in?
Our HSA requires a $2000 minimum to start investing. What would happen if the balance fell below $2000? Does it transition back to simply a savings account?
Could you walk us through the steps of getting the delayed payment and timeline of how long that takes to execute?
Thanks!
Reimbursement is very easy through our HSA, you simply link a bank account and then request reimbursement for whatever amount you spent. I throw receipts in a folder for that tax year after reimbursement. On the investment side, at least for our account, we choose a minimum threshold and every incoming dollar above that gets invested. If you spend money, it will automatically sell investments to put you back up to the threshold limit.
No. You just pull it out and report it on the appropriate tax form. If audited, you need to show the auditor receipts.
You’d have to ask your HSA provider exactly how it works, but I suspect $2000 gets left in cash and anything above that can be invested.
My new job will have an HSA which I am very happy to open. Plus they will contribute up to 2k per year! Everyone is healthy and our medical expenses are pretty low so I expect this to be a great addition to our portfolio. If something happens we can always get the “regular” insurance later
On that note – when employers contribute $$ to the employees’ HSA account, I believe, that counts against your yearly max. So in your case, you can only contribute $5,000 for the year instead of the $7,000. Please, someone correct me if I’m wrong.
It’s not like a 401(k) employer match, which is over and above the $19,000 limit.
My employer has gotten rid of all the traditional plans this year so everyone is on a high deductible plan. They contribute 1000 to your account which decreases the amount we can contribute to 6000 to make the max for this year. It is causing a big fuss since most people are worried about having to pay out of pocket for expenses. I have done a fair share of talking down folks at my hospital. Even some high income physicians and others are worried about the change. I have referred a few here already but this post should help.
Kind of ridiculous isn’t it? Amazing the level of financial illiteracy among docs sometimes.
You say that like an employer contribution is a bad thing. I’d much rather my employer put in $7K than I have to put in $7K. But yes, that’s the way it works.
Employer contribution is the opposite of a bad thing, it’s icing on a cake. Just a word of caution so that people don’t contribute over the yearly max. That component can be confusing for those not in the know.
Our HSA has been great for us. It is through my wife’s work (Health Insurance company). When I ran the numbers, the HSA plan was the best plan in every situation. Ours is held through Optum Bank and seems to be pretty good. They have an app and I simply take a picture of the receipt and can store it against the expense. Can then go in and reimburse myself at a later time, it works pretty slick and no file of paper receipts.
No HSA. For my employer, it only makes sense if you use no healthcare or a very large amount and get to the OOP maximum. Not good for any family with frequent but not exorbitant medical needs. My wife’s insurance is similar. The stealth IRA doesn’t work as well if you need to use all or most of the money you put in each year. Better to have lower health costs through traditional insurance and save more. Also less stressful…but I’ll review again next year.
Yup, choose a health care plan first. If the plan that is right for your family is an HDHP, then use an HSA. But don’t put the cart before the horse.
Question – what happens if you go High deductible, set up HSA but then decide / have to change back to a regular insurance plan in a few years. What happens to the HSA?
You keep it and can still use it for medical expenses.
Thanks! But I imagine you can’t continue to contribute more at that point?
That’s correct.
Generally speaking, employers set up premiums so that the HDHP offers cost savings in most claims scenarios. Lots of variables, including deductible levels and whether the employer contributes to HSA.
You also should consider what you’re getting with the traditional PPO. Office Visit copays of say, $40, seem great, but the same office visit under the HDHP may only be $80. Look at the Delta of the premiums, plus tax savings on HSA contributions, and what you think you’ll spend in heath care. Most people are surprised that the HDHP comes out ahead more often than not.
“In addition, if the contributions are taken out of your paycheck by your employer, they are not subject to payroll taxes like Social Security and Medicare either.”
I’m always confused by this line as it’s often touted as a benefit of an HSA without a clarifying statement, but isn’t it largely (SS at least) irrelevant for high income professionals? The 1.45% isn’t nothing, so that’s great, but I feel like most readers will have higher than $128k AGI, thus making it a moot point.
It’s kinda of like how people talk about how their mortgage is (was? under new limits) tax deductible – but they didn’t realize that it didn’t matter if they weren’t itemizing (opposite problem for the above stated high earner vs. low earner).
Is there something I’m not understanding?
It’s small, but useful. You’re right that the SS doesn’t matter to most of us.
A couple other great aspects of HSAs:
– Many employers offer a ‘Limited Purpose’ FSA. It works like your typical FSA except it’s designed to work in concert with HSAs. You can use the LPFSAs for Dental and Vision expenses, but not for Medical. It has the same $5,000 limit.
– You can use the HSA on anyone in your household. Even if under employee-only coverage, you can use the HSA for a spouse’s or dependent’s heath expenses. It helps to think of the HSA as a relationship between you and the IRS, rather than you and your insurance carrier or employer.
– Eligibility rules for HSAs (HDHP, no VA benefits/Tricare, no FSA, etc) only govern pre-tax contributions. If you made contributions to your HSA while in a HDHP then move back to a traditional plan, you can use the HSA for your medical expenses under the traditional plan.
You can use a LPFSA on medical expenses after you’ve reached your deductible.
Excellent article. I have HSA account in my name. I will be going on Medicare soon. How can my wife and kids maintain a HSA account since I will no longer qualify.?
You can keep it, you just can’t add to it. But in your case if your wife and kid are still on an HDHP a full $7K family contribution can be made. In fact, she can probably even do the catch up contribution (55+), an extra $1K.
I have an HSA. Just got married. My husband is not not on my medical insurance and does not have his own. I know the family limit for contribution is $7k. Can I now contribute this much to my HSA?
Yes, assuming you’re covered by an HDHP.
Be aware of the 13 month rule.
https://learn.hellofurther.com/Individuals/Life_Changes/Family_Changes
Be careful with transitioning to Medicare. For some reason, there is a 6 month ‘look back’ period for folks getting on Medicare where HSA contributions are not allowed. So if you enroll July 1, the last allowed contribution you make will be for December.
Interesting. Never heard that one either. Funny how many little rules there are to keep track of.
The last few years I have made it a priority to max out our HSA. And the contribution limits have been increasing pretty regularly hopefully that keeps up. It is a very underutilized account that many high income professionals don’t understand. Nice exhaustive list of the benefits.
Jim,
Do you foresee the allowance of HSA accounts to be used with Christian sharing organizations such as MediShare, Samaritan, etc in the future?
You can use them, you just can’t contribute to them. But no, I don’t see that changing any time soon. Who knows though, it’s Congress. They do some crazy thing sometimes.
In an attempt to prolong tax deferrable, is it possible to leave your children’s HSA accounts (rather then to them individually) as the beneficiary of your HSA funds?
No, it’s all 100% taxable income to your non-spouse heirs in the year you die. It’s no longer an HSA.
Is it possible for your heirs to use the receipts strategy with receipts you saved up in order to reduce the taxable amount? Or is it too late after you die for your heirs to utilize the tax-free distribution for previously uncompensated medical expenses?
I suspect you could do it in the year of your death.
Question. I am married, have two kids still on my health plan, and have an HSA (love it). My wife works at another institution, and we just figured out we save quite a bit by having her go off my plan and get health insurance through her employer (wish I had figured that out a few years ago). So she signed up for the high deductible plan for herself with an HSA, and I have a high deductible family plan with no spouse. Am I correct to in thinking that in total, I can put $7k in my HSA and she can put another $3.5 k in her HSA?
I think we looked into this a year ago when another commenter had the same question. I can’t remember what we decided. I think it was unclear but probably not okay to do that. Let’s see if someone else can cite chapter and verse on it this time.
The Finance Buff says you can’t do that. It’s $7K total.
https://thefinancebuff.com/hsa-contribution-limit-two-plans-mid-year-changes.html
This article agrees with him: https://solutions.americanfidelity.com/archive/hsa-mistakes-to-avoid-spouse-rules/
Chapter and Verse as requested:
If each spouse has family coverage under a separate plan, then the contribution limit for the two of them combined is $7,000 in 2019. The contribution limit is split equally between the spouses, unless they agree on a different division (IRC Sec. 223(b)(5)(B)(ii);IRS Notice 2004-50 Q&A 32).
However, if each spouse is 55+ and covered on their own HDHP, they can each make the $1,000 catch up contribution.
Thanks! So $9K if both 55+. Interesting.
Thanks for the info; helpful but disappointing.
Another benefit of HSA contributions is if they are made by your employer via payroll deduction, the contributions are not subject to FICA tax. This is not true if you make the contributions yourself.
As noted by another commenter, for docs that’s only the 1.45% employee half of Medicare tax.
I’d love to fund an HSA but my employer covers about 6,000 of the 7,000 annual premium that my insurance costs.
HSA’s are pretty much for those who don’t have very generous employer sponsored insurance. 🙁
If it is HDHP, you’re in wonderland! Hello Stealth IRA!
My deductible is very very very low. 🙂 Even better.
I would love to participate. Unfortunately, I’m not eligible. My HRA pays by deductible enough that my health plan isn’t considered “high-deductible.
Note that there is no penalty for withdrawal of the money for any purpose after 65. Even if it isn’t used for medical reasons.
Can a person obtain a HSA if self-employed and self procured kaiser insurance? Thank you
If the Kaiser insurance is classified by the government as an HDHP, but my understanding of Kaiser is that their plans are HMO plans, not HDHP plans.
Kaiser does have HDHP plans in addition to HMO/DHMO.
Thanks!
I have a wife and one young child, roughly $4k annually in prescription medication costs for the family, and am eligible for HDHP with HSA that my employer will contribute about $3700 to annually. Preventative care (well-child visits, immunizations, etc) is still covered 100% even in HDHP. This means my employer contribution will nearly cover my fixed medical costs but only leave a few thousand before hitting HSA max annually, and any unexpected costs (or planned costs like another child in coming years…) would have me hitting my $6k family deductible. It seems like this might not be the best option for me given my high Rx costs – does this make sense? Thank you for your thoughts!
Nobody was arguing in this post that the right insurance plan for YOU is an HDHP. If the right plan for your is an HDHP, then be sure to use an HSA. If it isn’t, then don’t bother with the HSA as discussed here.
https://www.whitecoatinvestor.com/should-i-get-an-hdhp-just-to-use-an-hsa/
It’s hard to determine what is ‘best’ without the other pieces of the puzzle. Consider:
– What’s the annual difference in YOUR premium contribution between the HDHP and the PPO?
– What are the deductibles and out of pocket maximums for the HDHP and the PPO?
– What are the drug benefits on the PPO?
– Does the PPO have an account tied to it that is funded by your employer, such as a HRA?
Also, keep in mind that in-patient hospital services, such as a delivery, are rarely covered by insurance with copays. For most PPOs and all HDHPs, you have to pay the deductible up front first.
Getting $3,700 in free HSA money from your employer sounds wonderful. The numbers would have to be really tilted against the HDHP for the alternative PPO to be ‘better’.
Assuming I have an HSA and I have cash available for HSA-eligible expenses, which is a better way to fund those expenses: from cash or the HSA?
Essentially I am wondering if it is better to avoid HSA use so that the account can grow. (My HSA allows investing our balance).
Some debate here, but the answer is either spend it as you go along OR leave it invested, save receipts, and pull it out in retirement using those receipts and retirement health care expenses.
https://www.whitecoatinvestor.com/the-best-ways-to-use-an-hsa/
Thanks for the article and the useful information. Our practice went to a HDHP + HSA a few years ago and I’ve been maxing it out every year. I currently have about 17K in my HSA. Thanks in large part to this article and the WCI, I’m ready to start INVESTING those HSA funds, rather than just watching them sit in a savings account that brings in tens of dollars per year in interest. : (
Here’s my question. . .let’s say I put my HSA funds into Vanguard or a similar fund. Do you recommend I put the entire balance of my HSA into that investment fund, or should I withhold enough to cover 1 year of my high deductible just in case of a medical catastrophe? Basically, how easy (or difficult) is it to move that money from the investment account into a quickly usable form? Or is it all in the same bucket, which would make my question a moot point? Thanks for the info.
– CMD
I invest as much as I can stuff into the investments, our plan requires at least $1K in cash. I figure that is enough to cover most of our expenses, remember you should have a few hundred dollars consistently dropping in with each paycheck. With the $1000 cushion, plus the consistent deposits, and our regular cashflow (if needed), we can cover our medical expenses without issue.
Some docs, like me, fund it all in January rather than dripping it in with each paycheck. But I agree I can pay my deductible with monthly cash flow.
Thanks for the feedback.
CMD
Thanks so much for the info.
CMD
If you’re planning to use the HSA money if you need to pay that deductible, then I’d keep that much in cash. But a stock mutual fund is VERY liquid. You can exchange it for cash any day the market is open. Of course, if you’re in the midst of a bear market that may not be wise.
Got it. Thanks for your feedback.
CMD
How do most people contribute to HSA’s? Lump sum once a year or in monthly/bimonthly payments straight from their paycheck?