It is quite possible that it is smarter to use your HSA dollars for healthcare expenses this year rather than letting them compound for decades and then using them to buy a boat. However, there are 7 guiding principles that should be applied when deciding how to use your HSA.
7 Principles to Guide How to Use Your Health Savings Account
Principle #1: An HSA is your only triple-tax-free account
When you contribute to an HSA, you get a current-year tax deduction. Your money also grows in a tax-protected manner over the years. Finally, when you pull the money out, as long as you spend it on healthcare, it comes out of the account tax-free. This is better than “double tax-free” 401(k)s and Roth IRAs, so it should be the first investing account you fund each year, after ensuring you receive any available employer match.
Principle #2: An HSA should be allowed to compound for as long as possible
Since the HSA is completely tax-free, it should grow faster than any other account. Thus, it is best to keep the money in that account for as long as possible to allow the maximal compounding of your investments.
Principle #3: HSA dollars are best spent on healthcare
HSA dollars can be spent on anything, but if you spend them on non-healthcare expenses prior to age 65, you will not only pay taxes at your marginal tax rate on the entire withdrawal, but you will also pay a 10% penalty. After age 65, that penalty goes away, but you will still have to pay taxes on the withdrawal. Because of these taxes and penalties, it is best to spend HSA dollars on healthcare, but if you must spend it on something else, do so after age 65.
Principle #4: Spend your HSA prior to death
When you and your spouse die, your HSA money becomes fully taxable income to either your estate or, if you have named a beneficiary, to the beneficiary. There is no such thing as a “stretch” HSA. Thus, it is one of the worst types of accounts to inherit. It is far better to inherit a Roth IRA, life insurance, or even a traditional IRA. So try to spend your entire HSA prior to dying and leave something else to your heirs.
Principle #5: HSA dollars do not have to be withdrawn in the same year as the healthcare expense
Although this rule may change at the whims of Congress, as the law currently stands you do not have to withdraw money from your HSA in the same year you purchase healthcare. Thus if you have a baby at age 35, if you keep your receipts, you can take that HSA money out at 55 and use it to buy a boat — tax and penalty-free.
Principle #6: The higher your tax rate, the more beneficial it is to use the HSA instead of non-qualified (taxable) dollars
If you have a 50% marginal tax rate in your peak earnings years, but only a 30% marginal tax rate in retirement, there is an advantage to using HSA dollars earlier in life. This isn't because it affects health care spending, but because it affects the tax rate at which you can pull the money out if you spend on something besides health care. However, this minor advantage is frequently outweighed by the long-term, tax-free compounding and the ability to invest more aggressively in the HSA due to the longer time horizon.
Principle #7: HSA dollars are not protected from creditors
Although there are a few states which exempt Health Savings Account dollars in bankruptcy, (FL, MS, OR, TN, TX, and VA) most states do not. Thus, in the event you are the very rare target of a successful lawsuit with an award beyond your insurance policy limits, it is generally better to have money in a 401(k) or Roth IRA than an HSA.
So how can we apply all of these principles to determine the best way to use an HSA?
The very best way is to use an HSA is to pay for all of your healthcare benefits throughout your life. This allows you to purchase all of your healthcare with pre-tax dollars. However, your future healthcare expenses are completely unknown.
Your HSA may either be much larger than your healthcare expenses, or it may be much smaller than your healthcare expenses. So you have to make an educated guess, and then adjust as you go along in order to arrive at the optimal strategy.
If you think your HSA is larger than future healthcare expenses, be sure to spend it on any available healthcare expense you may have throughout your life. If you reach age 65 and still have a huge HSA, then treat it like a regular old IRA, spending it on any expense with the aim of having the account keel over at the same time or just before you do.
If you think it is smaller than future healthcare expenses, then pay for your current healthcare needs with non-qualified (taxable) dollars, and save that HSA for retirement healthcare expenses. If you are not sure, then spend using taxable dollars now, but keep your receipts.
A Health Savings Account is a great way to reduce your taxes and decrease the after-tax cost of your healthcare. Using it optimally will allow you to maximize your spending, giving, and financial security throughout your life.
How do you use your Health Savings Account? Do you use it for medical expenses now or are you planning to use it on something other than healthcare after age 65? Sound off below!
I think the HSA is one of the best accounts out there. I wish the limits were higher, but take what you can get. Assuming your situation warrants a HSA(you can afford the deductible rather than a higher premium for lower deductible) then I would suggest max contributing to the HSA. Most employers have HSA providers that they recommend, but if not, where would you recommend setting this up? I haven’t seen any evidence of late yet I know when ACA was being debated, HSA’s were on the chopping block(only the wealthy were taking advantage) so hopefully this is a benefit we have for the long run.
I found the old post about providers although I’m sure there are new players.
I’m sure there are. I’m still with HSA Bank/TD Ameritrade.
I’m there also. Simple rules, and I only have to log into TD Ameritrade account once a year to buy new shares. Also like that there are about 100 mutual funds that are free to buy as long as you hold them 60 days, which is a non issue.
Sorry, I meant ETFs, but I just use the ones with corresponding mutual funds.
With regard to Principle #2: Why would an HSA’s withdrawal benefits affect its pre-withdrawal growth? In other words, why would an HSA grow any faster than a standard tax-deferred retirement account?
Probably should have phrased that differently. It grows faster than many accounts since it grows tax-free. Assuming the same fees and investments, it will grow exactly the same as a traditional IRA (but obviously worth more on an after-tax basis.)
I think that the HSA is fantastic, especially when you are young/healthy. You not only get to choose a health insurance that has a lower premium, but you get the HSA. If something happens and you absolutely need that money for a health emergency, it’s there for you.
I think another great benefit is that you don’t have to withdraw money for medical expenses in the same year. That way, you can spend money you have on health expenses and later on (even years later) withdraw money based on the amount you previously spent. That way you have the triple tax benefit, and can use that money for a different expense. It’s the only way you can “touch” a retirement account before retirement without penalty! Amazing!
And not to mention that the HSA counts for you and your dependents, even if their health insurance does not qualify for an HSA for themselves! I mean the HSA is amazing!
I have mine through HSA Bank/HSA Administrators, they have access to a number of Vanguard funds at the admiral level.
That’s not the only way to touch a retirement account early.
https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/
Interesting situation, my employer has a HDHP for all partners. However, any deductible as well as costs up-to some double digit number that I’ve never hit are reimbursed to the individual.
Looking at the letter of the law on http://www.irs.gov/publications/p969/ar02.html I should qualify, since my HDHP is my only coverage. Does the reimbursement aspect disqualify me from using an HSA?
That sounds like an HRA, and my understanding is that an HRA doesn’t disqualify you from having an HSA.
http://www.zanebenefits.com/blog/bid/97341/FAQ-Can-I-have-an-HRA-and-an-HSA-at-the-same-time
I am using HSA Bank/TD Ameritrade. Keep over $5000 at HSA bank to avoid fees, and everything else in TD. Each year I do a max lump sum contribution to TD and purchase Vanguard LifeStrategy Growth Fund (VASGX) (80/20 stocks/bonds 70/30 US/International). There is a $25 fee for each purchase at TD. That is the lowest fee diversified solution I could come up with.
Why not just buy a Vanguard ETF? I just buy VTI at TD Ameritrade. This year I quit leaving the $5K at HSA bank. There is a fee, but I’m hoping in the long run the return of the investment will overcome it.
As of Nov 2017 VTI is no longer commission free. Would you still buy it or go with something like SPTM?
My wife and I are both starting new physician jobs on the east coast. Both companies we work for offer a HSA but reading the fine print seems to indicate that we can only roll over $500 from one year to the next. This would negate any benefit of investing any more than $500/year unless I had a really good idea of what my expenses would be. Any recommendations? Is this common or unique for HSAs? I appreciate your blog and your thoughts
Dan, it sounds like your companies are offering a Flexible Spending Account (FSA) instead of a HSA. You get to tax deduct contributions to a FSA however you surrender anything left over the rollover limit at the end of the year.
Are you sure that’s an HSA? It doesn’t sound like one. It might be some weird type of an FSA.
What exactly constitutes “health expenses?” Would long-term care expenses, such as private hire nursing or SNF payment, count? If so, this seems like a great way to also self-insure for LTC.
Yes, those would count. The government describes HSA-eligible expenses here:
Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.
Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They do not include expenses that are merely beneficial to general health, such as vitamins or a vacation.
Medical expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract.
http://www.irs.gov/publications/p502/ar02.html#en_US_2014_publink1000178851
Be aware that “in home help” isn’t covered, but in home nursing is.
Dear WCI
I am 37. If I don’t touch my hsa until 65 yrs old and keep record of all my health expenditures over the next 30 years can I pull that amount out tax free at 65? Thanks in advance
You can pull it out at 64, 65, 66 or whenever.
Be aware that law could change.
Thanks for the article. Is it realistic to expect, say, a 30-year old to keep receipts on healthcare expenses for 35 (!) years? Are the tax savings on potential earnings (the principal was already tax free) worth the trouble? For many, the answer will be “No!”
I think the most important consideration is whether the person is already maxing out their 401(k) (or TSP or other similar plan) and IRA or Roth IRA. If so, then yes, the person likely has the income, wherewithal, and incentives to max out an HSA as well and gain the extra tax savings on earnings by “cashing in” after age 65. Assuming the paper receipts or scanned hard drive backups don’t get lost or broken during a move, house fire, etc. over the decades. Even for an organized and motivated young person, that’s a lot to ask.
If, like the vast majority of workers, the person is not maxing out or cannot max their 401(k)/Roth IRA, then there is no strong reason to hang onto receipts for decades. Just pay current healthcare expenses out of the HSA and try to increase contributions to the “regular” retirement accounts.
I agree.
But keep in mind for many young, healthy families, the “big expenses” only come along every so often. I don’t keep the $12 receipts, but you better believe I’m going to hold on to the one for our upcoming delivery/hospital stay.
We are married physicians expecting a child this year. I have funded an HSA for years and wonder if it makes sense to begin to fund hers even though we will have a high expenditure healthcare year?
You are aware that the limit is $6650 per family for HSAs, right? If you’ve already contributed $6650 to your HSA for 2016, you can’t contribute more to a different one for your spouse or child.
I’ve been contributing the single person max ~$3300. This is the first year we’ll be married. If I have a high deductible policy but she has an HMO what is our max?
Well, if you have at least one other person on your plan, then it’s $6650. If not, it’s $3300.
Does it make more sense to pay for childbirth and deduct the costs from taxes now or fund her HSA?
It makes the most sense to do both. If you can’t afford that, then it is best to fund the HSA, then immediately take out the amount to pay for childbirth from the HSA.
If each physician spouse working for two different companies has access to an HSA and there are three children, is it better to have one HSA under one spouse for the whole family or each spouse have an HSA?
Great question. You can do the family contribution with just one adult and one kid. But my understanding is you don’t get an additional contribution amount by using two HSAs. More details here:
https://support.tangohealth.com/hc/en-us/articles/204143614-Rules-and-Best-Practices-when-Spouses-are-Both-HSA-Eligible
That guy argues you’re better off doing two accounts, but if you read the whole article you’ll see there is very little advantage there for many couples. It wouldn’t benefit my family at all to have two accounts for instance.
For those of us paying for our own medical insurance, our twelve monthly health insurance payments will eat up about three years worth of HSA contributions. That is NOT a lot of paper.
My understanding is that you cannot use HSA money for health insurance premiums (except COBRA and a few other exceptions). Which is utter nonsense if you ask me, but the law is the law.
https://www.wageworks.com/employees/support-center/support-and-faq/healthcare/hsa/can-i-use-my-hsa-to-pay-for-health-insurance-premiums/
Premiums for Medicare Part B, Part C (Medicare Advantage), and Part D (Prescription Drug Plan) can be reimbursed from HSA. Premiums for Medicare Supplement (Medigap) cannot be reimbursed from HSA.
Addendum, using “Principle 5” (“HSA dollars do not have to be withdrawn in the same year as the healthcare expense . . . . Thus if you have a baby at age 35, if you keep your receipts, you can take that HSA money out at 55 and use it to buy a boat, tax and penalty-free.”) to address taking out money before age 65. Please correct me if I’m not understanding something–it’s entirely possible:
According to Google, the average childbirth costs the patient $3,500 out of pocket. A 35-year old, Alice, can pay that tax-free out of her HSA today, saving $630 (assuming an effective tax rate of 18%). That’s awesome! HSAs rock. Alice adds the $630 to her IRA contribution for the year.
Her friend, Betty, also has a baby, and leaves the $3,500 in her HSA, paying the $3,500 using the after-tax money in her checking account. She’s currently at -$630 compared to Alice. But she waits patiently for 20 years, during which time her $3,500 earns a respectable 7%/year. She’s 55 and her $3,500 is now worth $13,543.90. Baller. But wait–she can’t spend the earnings tax-free or without the 10% penalty for another 10 years. But Betty kept all of her childbirth receipts, so she spends $3,500 on a sail for her sailboat and doesn’t have to pay tax on it. Woohoo! She saves…$630. She’s finally squared-up with Alice. The only difference is the earnings, which Betty can’t touch until age 65. Meanwhile, Alice has been investing in her regular retirement accounts, which she can tap penalty-free as early as 55.
Is that correct? Again, healthcare expense tax savings using HSAs are great. Tax-free growth in retirement accounts is also great. But using the HSA as a stealth retirement account seems a bit overrated.
Maybe a bit overrated, but what it is really good for is that you now don’t have to worry about overfunding it. If you do, well, it’s another IRA. If you don’t, well, you’ll spend it all on health care.
Apologies, additional thoughts:
* The $630 savings is worth less to Betty in the year 2035 than it is to Alice today.
* Betty has the advantage of never having paid tax on her earnings. With a 401(k) or Roth IRA, Alice either pays them now or already paid them. This is the “Super Roth” concept of an HSA, giving Betty big tax savings on the earnings over 30 years (well, to the tune of $4,000 in the year 2045–what is that worth in today’s dollars?).
* When does a “good saver” family need a tax break the most? At age 35 — balancing career, kids, housing — or at age 65, when they are hopefully retired with respectable balances in their retirement accounts?
In sum, I’m convinced that this topic is more complex than I first realized.
Addendum addendum…
* It looks like the early withdrawal penalty on non-qualified expenses is 20%, not 10%.
Whether to use my HSA funds now or after retirement has been weighing on my mind a lot. However, now at age 64 I have another concern. Since HSA contributions reduce my reported Soc Sec earnings, and thus reduce my calculated future Soc Sec benefits for what could turn out to be 20 to 30 years, I wonder if I should suspend my HSA contributions for my last few working years. Has anyone tried to analyze that?
If self-employed, they don’t reduce your SS earnings. This isn’t a big deal for most who work well into their sixties anyway, especially doctors, since they’re already way over their SS earnings limit. Taking $6K off that isn’t going to get them anywhere near $117K or whatever it currently is.
Continuing to read about this topic on other sites (I recommend the Bogleheads wiki w/ the linked discussion thread: http://www.bogleheads.org/wiki/Health_savings_account#cite_note-1).
I was wrong about an HSA becoming a “Super Roth” after age 65–the money is taxed just like a traditional 401(k) or IRA if it’s spent on non-health expenses. There is just no 20% penalty anymore.
As John notes, an HSA reduces Social Security income, unlike a 401(k) or IRA. From my limited reading, this matters more at low income levels. John, in addition to SS benefits (calculators at http://www.ssa.gov/planners/benefitcalculators.html), make sure you research how HSA contributions after age 65 affect Medicare eligibility.
Someone mentioned this on Bogleheads and I tend to agree. It is very difficult for me to explain to my spouse why we shouldn’t be paying for healthcare from the account specifically designed for that purpose and instead use a credit card and keep the receipt for 30 years. You have to admit that sounds absurd. I fully fund an HSA each year but I use the accompanying credit card to pay for all of our healthcare related purchases. If I lose 30 years of tax free gains so be it. The wait 30 years to touch it concept assumes the government keeps the HSA rules the same. Not to be cynical, but I feel pretty confident in saying only high income earners are fully funding and exploiting HSA accounts in this way. Seems like an easy target for future tax increases. Just saying!
You may be right. I wouldn’t be surprised to see that law get changed.
HSA sounds fantastic.
Would it make sense that I max out my HSA at every given opportunity, while paying for everything NOW myself, keeping the receipts.
Once the money grow 30-40 years tax free, then I pull the money out tax free to pay for these expenses that I already paid for…
in other words, i’d be putting $1 pre-tax dollar in at 31, paying for my health expenses for the next 35 years myself with health insurance and copay, allowing this $1 to compound @10% for 35 years, which becomes 28 dollars.
then at this point, i take out the whatever amount for the medical expenses in the past at 1/28 ratio tax free.
that sounds really sweet. but is this correct or did i miss something?
Just to be clear on the HDHP requirements for an HSA, when the IRS says that a family plan in 2015 has to have a “Maximum annual deductible and other out-of-pocket expenses of $12,900,” does this mean that the health plan has to have a max amt HIGHER than $12,900, or that 12,900 is the max allowed? My plan has a $13,200 max out of pocket expense if this helps clarify the question.
That probably isn’t an approved HDHP. For 2015, it’s $12,900. For 2016, it’s $13,100. Might want to call and ask why their limit is different from the approved limit.
Is an HSA subject to net investment income tax?
No. It grows tax free.
If my employer offers a great healthcare plan with low premiums, thus not qualifying as a HDHP, can I sign up for it with my children enrolled while enrolling my wife into a HDHP and HSA or do we all have to be on the same plan?
As a general rule, get the best plan first, then if it is an HSA plan, use an HSA. Don’t take a more costly plan (to you) in order to get an HSA. An HSA isn’t THAT great. If only your wife is on an HSA-eligible plan, you’ll only get 1/2 the HSA contribution.
I agree with WCI about getting the best health plan first. If you run your numbers, the annual savings in premiums alone (presumably low because of an employer subsidy) along with your decreased out of pocket annual healthcare costs might negate the advantage of HSA savings. Just depends on your situation–your family’s healthcare requirements.
If your family is young and has essentially no predictable healthcare requirements that require annual out of pocket costs AND for whatever reason you want to maintain maximum HSA eligibility you could look into having an HSA eligible plan for your wife and at least one kid so that you can make the family contribution of $6750 for 2016.
I hope the following does not apply to you: For an employed person such as yourself, the only situation I can think of where you would really be compelled to split up your family between a good employer’s healthcare plan and an HSA-eligible plan is if, God forbid, one of your family members incurs chronically high out-of-pocket health care costs. In that case, assuming your employer’s plan is appropriate, you’d want that ill family member to be on your employer’s plan with you to maximize their healthcare coverage. You could then have a healthy parent and healthy kid with no healthcare costs on a separate HSA-eligible HDHP. Maximize your HSA contributions annually and then use those the HSA funds to cover the out-of-pocket costs of your less healthy family member even though they’re on the employer’s plan. You don’t need to be in an HSA-eligible HDHP to use HSA funds. You just need to be in an HSA-eligible HDHP to save HSA funds.
Anyway, for someone in the scenario above, this approach would allow you to use pretax funds to cover some healthcare costs before getting to the 10% of AGI threshhold for deducting healthcare expenses.
One thing that I’m not clear on: What happens to your HSA if you switch from an eligible (HDHP) to a non-eligible (low deductible) plan later?
So if you are healthy and choose a high deductible plan and fund an HSA for 10 or so years, but then decide to switch into a low deductible insurance plan later are there any penalties on that HSA that you’ve built up? Can you use it to pay the higher premiums that may be associated with a new plan?
No, no penalties. But paying premiums (other than Medicare part D I think-double check if that applies to you) isn’t an HSA-eligible expense.
At age 65, you can use your HSA to pay for Medicare parts A, B, D and Medicare HMO premiums tax-free and penalty-free. You cannot use your HSA to pay for Medigap insurance premiums. You can also use your HSA to pay the employee share of premiums for employer-sponsored health care (employee paid portions of employer sponsored health care may already be pre-tax). Using HSA money is an especially good method to pay for Medicare as it is challenging to pay for Medicare with pre-tax dollars. If your Medicare premium is automatically deducted from your Social Security check, you simplify reimburse yourself directly from your HSA for the Medicare premiums paid from your Social Security payment.
https://www.hsaresources.com/pdf/Turning_65.pdf
Cool news! Thanks for the update.
i have kept medical bills over the last 7 yrs they roughly come to 25k. Is it legal to get 25k out of my HSA tax free if I chose do so?
Yes.
Hi Jim
I was wondering if we are planning to have our first kid some time in the next year, should we elect to go for a low deductible or high deductible plan with HSA.
Does the medical cost associated with maternity care offset the amount we would potentially save putting money in the HSA?
Thanks again.
Probably. A delivery is expensive, $5K seems about typical. Basically in a year where you know you’re going to hit your max out of pocket, pick the plan with the lowest max out of pocket! If that’s an HDHP, then use the HSA. But don’t let the HSA tail wag the health insurance dog.
If I have an HSA for my personal HDHP through my employer, but the rest of my family is on a different policy, could I use my HSA dollars for their healthcare or just my own?
Theirs, but you can only make a single contribution.
I max out my allowable HSA for a family each year and do not plan to touch it until I retire, treating it as a stealth IRA.
The triple tax break is a big plus for me and the reason I cash flow current health expenses. A lot of people balk at the idea of saving health expense receipts for potentially a few decades. But even if you do not keep receipts, the likelihood of having Healthcare expenses in retirment use up your available HSA is pretty high (statistics say a 65 yo couple can expect to have $250k of Healthcare expenses in retirement and that is now, this number likely to rise by the time I retire as these expenses have outpaced inflation).
I didn’t know that it was so relatively undesirable to leave an HSA to your heirs. If I croak before my spouse, will she be able to inherit and use my HSA money for her health care expenses tax-free?
Yes, but not any other heirs.
So I assume, the procedures would be:
Keep everyhealthcare expense receipt from the start of the HSA until one passes.
The question is, will those receipts still qualify after the death?
I don’t see why they couldn’t be applied in the year of death. But I wouldn’t try it after that.