OK, I admit it! I have a favorite savings crush (among all the savings buckets). It's my health savings account. Sorry, 401(k), I still love you so much, and you have so many great qualities. You're just not quite as great as the HSA. So as we enter open enrollment I have to explain this often misunderstood love interest, I mean, savings bucket.
HSAs are accounts available for eligible high-deductible health plans. HDHPs are health insurance plans that ask the insured person to pay a higher deductible for health care, the first couple to several thousand of health expenses before insurance pays. An HDHP typically benefits from a lower premium than a low deductible plan. In my mind, pairing HDHPs with an HSA account allows the insured person to bank the difference in premiums in a tax-advantaged HSA savings account to mitigate the risk of paying a relatively higher amount for healthcare out of pocket.
Most people probably think of their HSAs like the flexible spending accounts that have been around for longer and are associated with the well-known phrase "use it or lose it." HSAs are not use it or lose it and can accumulate over time. More importantly, unlike an FSA helping with copays or smaller expenses, HSAs are critical partners for the larger financial burdens that can come with higher deductible or out-of-pocket maximum costs. In other words, we need to be probably saving more in HSAs than FSAs.
Let's take someone with a $3,000 deductible but no savings. With one trip to the ER (with a later MRI), the HDHP deductible hammer drops swiftly, hard and mercilessly when those bills come. The last thing someone needs in the middle of a health event is a sense of panic as they wonder where the money will come from to pay those bills.
At minimum HSAs are an important savings tool to defend against potentially devastating health care expenses.
But what many people don't realize is that the HSA has tax attributes that make it more attractive as a retirement account.
Before I get into these attributes of the HSA, keep in mind that a health care choice must be made independently of the HSA benefit. Assuming your numbers and expectations make an HDHP a reasonable choice, then, and only then, should you consider engaging in a lifelong love affair with this often overlooked, sophisticated yet somewhat nerdy savings bucket.
Unlike the FSA, the HSA savings bucket has all the makings of a committed, lifelong relationship with its triple tax advantage. Yes, three of them. No income taxes on the front end contributions, no taxes on the growth, and no income taxes on the back end withdrawals as long as they are used for qualified medical expenses.
Let's say an HSA-eligible HDHP is your best (or only) choice for health care. You sign up for your HSA-eligible HDHP. You open the HSA. You have contributions payroll deducted into the HSA, getting your tax deduction. You have the same trip to the ER and the MRI. But you don't use the HSA to pay those expenses--opting to use alternative savings.
Instead, the money you were payroll deducting into the HSA stays put and accumulates in that account.
The government doesn't give a time limit on when you must spend the HSA. If you use the HSA on qualified health care-related expenses you pay zero taxes on that money, even in retirement. Even after investments have grown your savings.
Let's say you are 30 years old reading this and instead of opening that Roth like the old days, you choose the HSA strategy. A family contribution max is $7,300 this year. Assuming the same contribution over 30 years and a 5% rate of return, you could accumulate over half a million dollars for retirement health care spending that is NEVER TAXED. Not one dollar.
Oh, and fun fact, what's the largest expense on average in retirement? Health care. Think Medicare Part B and D premiums or Medicare Advantage plans. Or dental care. Or vision expenses. Or prescriptions. I promise the list goes on. Remember that HSAs can be used to pay for long-term care expenses. Folks, not sure the last time you priced out long-term care insurance, but if you did you might conclude the premiums are unaffordable. HSA, anyone?
But, wait! What if we "fix" health care by the time we retire? Does that mean we wasted our savings? Um, in that "worst-case scenario," money can be used on non-health-care-related items in retirement and would be taxed the same as an IRA. That's why many refer to HSAs as "stealth IRAs."
What if you change your mind? You get to age 45 and spent over a decade maxing out the federal savings limits into an HSA, paying for health expenses from your bank account, not the HSA. No problem! If you saved all health care receipts over that time (many HSAs let you scan and store the receipts in your account) then you can at any point "cash out" those receipts, again tax-free.
Now setting this HSA up. Unlike the 401(k), you are not captive to using the employer's HSA option. I recommend starting with your employer and asking if their HSA allows for investing. If so, probably stick with the employer HSA option. If your employer has an HSA that is essentially a savings account but the employer contributes then by all means set up and keep that HSA! Then you can establish a second HSA account on your own with companies like Fidelity, HSA Bank or Optum Bank. You just have to make sure your contribution in the outside HSA plus the employer contribution at the employer-based HSA do not exceed federal limits.
In 2023, individuals can contribute up to $3,850 and families up to $7,750. There's even an age 50 catch-up contribution of $1,000.
Many HSAs make you maintain a cash position of $1,000 to $2,000, but the minute you are over that threshold you can start investing. Luckily a lot of HSAs have simple investment options, like my favorite target date retirement funds.
Finally, and most importantly, if you are using this long-term HSA strategy you have to tuck away extra money in a savings account at your bank to cover the possibility of hitting your deductible or out-of-pocket max. Otherwise, game over. You will be forced to use the HSA prematurely for health expenses.
Now I know what you all are thinking. This really is better than a 401(k). Way better taxation and even more flexibility to be able to set up the account outside the employer if you want. But WAIT, you have to remember that often retirement plans like 401(k)s, 403(b)s and 457(b)s have FREE MONEY via a savings match. If your retirement plan matches savings then the amount of free money you can capture with your own savings in your retirement plan will have a leg up over an HSA.
This enrollment period, if you choose an HDHP health care plan, please also save into an HSA to pay for health expenses. And if you have the means and interest, consider not spending out of it for near-term health expenses; instead invest those savings in a more committed, lifelong relationship with the HSA.
Many thanks to reader Claudia Utley for the suggestion that I dedicate a column to this juicy topic.
Sarah Catherine Gutierrez is founder, partner and CEO of Aptus Financial in Little Rock. She is also author of the book "But First, Save 10: The One Simple Money Move That Will Change Your Life," published by Et Alia Press. Contact her at firstname.lastname@example.org.