All About HSAs
I was late to HSAs, not in having one but in optimizing it to my advantage. And because the theme of these articles tend to be “I’ve learned the hard way so you don’t have to,” I will share my experience and learnings. The info I hope you can walk away with is what an HSA is, how it can be used, and ultimately how it’s BEST used.
What It Is:
Simply put — HSA stands for Health Savings Account, and functionally it’s pretty much what its name implies. An HSA is a tax-advantaged savings and investing account for use on medical expenses.
An HSA is different from its cousin FSA in two distinct ways. Unlike the FSA, in which the funds must be used up on medical expenses in a calendar year or they’re lost, an HSA can build over years and the balance will roll from year to year. And two, it can be invested to earn interest.
So an FSA (flexible spending account, if you’re nasty) is use it or lose it, and the HSA can build build build!
How To Get One:
An HSA can be offered by an employer or health insurance provider as a compensation component in a high-deductible health coverage package or can be set up independently. Much like a 401K account, money can be allocated to this account before tax, straight from an employee’s paycheck. Out of sight and out of mind.
The money in this account can be withdrawn at any time. BUT to avoid tax liability penalties, it should only be used for approved health and medical expenses. This includes doctor and specialist visits, prescriptions, emergency room expenses, physical therapy, mental health therapy and counseling, even household medical stuff like bandaids and over the counter medicine.
How It Works:
One can choose to pay approved medical expenses straight from this account using the debit card associated, or you can pay out of pocket and reimburse yourself from an HSA after the fact.
Investing Your HSA:
If your account builds past a certain threshold (for my account it’s $1000), the difference can be invested in the stock & bond market so contributions can start to earn compound interest. We love compound interest in saving! So an HSA allows users to have yet another vehicle for money growth. And since it’s specifically dedicated to health, it’s a great way to save for emergencies while earning some passive income.
Other Important Stuff to Know:
Because it’s got tax advantages, the IRS has limits on how much you can contribute to an HSA each calendar year. (Psst… a rule of thumb: if there are contribution limits, you know it’s a good thing!) In 2024 the limit is $8,300. And there are tax penalties for exceeding that amount.
Listen up because here’s the best part! An HSA is the ONLY triple-tax-advantaged type of investment product available. The contributions are tax-free, the growth earned from interest is tax-free, and spending on medical expenses are (you guessed it) tax-free! But these advantages only exist if invested. I’ll repeat for the folks in the back: When used as an investment account, HSAs offer triple benefits!
My Experience:
When I first got an HSA account through my health insurance policy, I used it as a medical expenses checking account, spending from it routinely for anything from doctor visits to counseling. Like a checking account, the balance just revolved and stayed around about $200 or so at all times.
This worked fine, but I was using it like an FSA, not an HSA, and I wasn’t able to take advantage of all of the benefits available to me. Plus the account didn’t earn interest so the balance just sat there.
Don’t get me wrong. Having a dedicated fund for specific expenses can be a significant life raft, and I almost always encourage sub-savings accounts for specific categories of planned large expenses or emergencies (like a wedding fund, house fund, or emergency fund), but the way I was using it, I would have been a lot better off having a fund like this in a HYSA where it could earn a bit of interest.
After some research I figured out that if I paid out of pocket (aka built our routine medical expenses into my monthly budget), that the HSA could grow enough to invest some of that money and earn interest for even more effortless growth. This benefits me in several ways.
I earn tax-free interest through that investment
I have more money in the account for big unexpected medical expenses
It will help with retirement planning, the season of life when most of us will have the highest percentage of medical expenses
Here’s a simple example to help drive home the point. If my daughter has to have a dental procedure that costs $500, I have two choices for payment. I can pay out of my HSA or I can pay out of my checking account. If I do the latter and leave that $500 in my HSA, those funds alone will grow to over $2,700 by the time I retire.* So if my monthly budget allows for an out of pocket medical expense, I do it. And I still contribute the maximum annual contribution to my HSA so that investment builds and interest compounds.
Now what’s my plan for a life-altering medical emergency before I retire (like that time I found myself in the hospital for a week fighting sepsis)? I will absolutely tap into those HSA funds without batting an eye. Because it’s there and can be used. It’s like a safety net that, if unused, still benefits us.
So there you have it. An HSA can be used either way you need — as a spending account for medical bills or as an investment vehicle for retirement. I’ve shared what works for our family, and now it’s your turn! Do you have an HSA? How do you prefer to use it — do you spend it on current medical expenses or invest it for future medical expenses?
*Calculation based on $500 principle earning 7% interest compounded annually over 25 years. Actual results may vary. Not financial advice.