Why are HSAs so powerful?

Claiming the HSA is the best retirement account is a very bold claim. Who could forget the mighty Roth IRA with its magnificent tax-free growth? Or how about the Roth 401(k), also with magnificent tax-free growth but higher contribution limits? Here’s why the HSA trumps both of them, when it is at its best.

Contributions to an HSA can be invested, and those contributions grow entirely tax-free, just like with Roth accounts. HSA money can be withdrawn entirely tax free, just like with Roth accounts. The catch is distributions must be used for eligible medical expenses.

Fortunately and unfortunately, most Americans will have plenty of medical expenses to utilize the money in their HSA. A study found that the typical American will spend over $300,000 on medical care over their lifetime. With an average HSA balance of $4,607, it’s safe to say that most Americans won’t have to worry about over-contributing to their HSA anytime soon. Even if you were to have more money saved in an HSA than eligible medical expenses to use it on, you could still use that money for any expenses at age 65 and beyond without penalty. The catch is that money is taxable, so HSA money used for non-medical expenses functions like a traditional IRA or 401(k) without the required minimum distributions (RMDs).

There is one great feature that takes HSAs a step above Roth accounts. Unlike their Roth counterparts, HSA contributions are tax deductible. To summarize, HSAs offer a tax deduction on contributions, assets grow tax-deferred, and distributions for qualified medical expenses are tax-free. This makes the HSA the only retirement account where your contributions may never be subject to federal income tax.

Now that we’re on the same page about how powerful HSAs are, how do you contribute and use them?

How to open an HSA

About 45% of employers in the US offer HSAs to their employees, so you may have access to a Health Savings Account through work. If you do, it could be best to contribute through your job as your contributions will be exempt from FICA tax. Your workplace plan might not have the best investment options, but you may be able to move money from one HSA to an outside HSA after getting the FICA tax break.

You could still be able to open and contribute to an HSA if it is not offered through your employer. If you meet the eligibility requirements to open an HSA, the biggest of which is to be covered by a high-deductible health plan or HDHP, you can open an account on your own without your employer. If you are eligible to open an account and contribute, look for a low-cost provider with a wide range of HSA investment options. There are many providers out there, and one we like is Fidelity for the ease of opening an account and the access to plenty of low-cost investment options.

How to take full advantage of an HSA

Only 10% of Americans even have an HSA, so if you made it this far, congratulations on being in the top 10%! There is still more work to do to fully utilize your HSA and make the most of this extremely powerful retirement account. One big mistake many Americans make is not investing HSA contributions. A study found that only 4% of HSA owners actually invest within their HSA. Doing some quick napkin math, if only 10% of Americans have an HSA, and only 4% of those Americans invest in their HSA, that means about 0.4% of the population is fully utilizing an HSA.

Now you might be thinking, “Okay, I know how to open an HSA and to invest my contributions, which puts me in the top 0.4% of Americans. Surely I’ve reached the pinnacle of HSA usage, right?” Not so fast, friend! Believe it or not, HSAs can be even more powerful if those invested assets are saved for the long-term.

There are two main ways to use the dollars in your HSA. The first is as a slush fund to pay for medical expenses in the present year. If you are using an HSA this way, it won’t make much of a difference if you invest the dollars in your account because they are spent so soon after contributing. The second way to use an HSA is to pay for medical expenses out-of-pocket and invest the money in your HSA and let it grow. That’s because there’s no time limit on reimbursing yourself for eligible medical expenses.

What this means in practice is you can save all of your medical receipts for years or even decades, let the money in your HSA grow, and take those reimbursements in retirement. We don’t know how many Americans use an HSA this way, but it’s certainly less than 0.4% of the population that invests in their HSA.

HSAs might just be the most powerful retirement account available to Americans, but only a small percentage of Americans are taking full advantage of all HSAs have to offer. When used properly, HSAs offer tax-free contributions, tax-free growth, and tax-free qualified distributions. That’s a combination that can’t be matched by any other retirement account available. If you aren’t currently investing for the long-term in an HSA, check to see if you are eligible, open an account through a low-cost provider like Fidelity if you don’t have one through your employer, and save all medical receipts and let your HSA grow for as long as possible.

Do I need health insurance?

The answer to the question of whether or not you need health insurance is almost always yes. Unless you are a billionaire and have more than enough money to cover any medical bill that could possibly arrive, health insurance is a good idea. No matter how young or old you are, how healthy or unhealthy you are, how much you dislike insurance or hate going to the doctor, you probably need health insurance. The benefits of health insurance may seem mundane; most people just save a little bit at the doctor here and there and don’t experience much savings, if any, from having health insurance. However, the greatest benefit of health insurance is that it covers you if you find yourself needing major medical care for whatever reason.

Without health insurance, what we think of as routine medical events, such as having a baby, could end up costing six figures if there are complications. It is impossible to predict when certain medical diagnoses will occur. A cancer diagnosis can happen to anyone at any time; treatments are always improving and your odds of getting a severe diagnosis may be low, but health insurance protects against those unknowns.

What type of health insurance do I need?

Health insurance isn’t always easy to understand and the options available may confuse you. While the available insurance options differ for everyone, there are two basic categories of plans to choose from: high-deductible health plans or traditional health plans. What is a deductible? This is the amount of money the policyholder pays before the insurance company starts paying benefits. The lower your deductible, the less amount of money you must pay before insurance kicks in. High-deductible plans have higher deductibles when you need care, but your monthly premium is generally lower. For 2024, a high-deductible health plan is any health insurance plan where the annual deductible is $1,600 or greater for single coverage or $3,200 or greater for family coverage. Additionally, annual out-of-pocket expenses must not exceed $8,050 for single coverage or $16,100 for family coverage.

High-deductible health plans (HDHP) come with the added benefit of HSA eligibility, which is one of our favorite retirement savings vehicles. If you are healthy and not expecting any medical expenses outside of a few visits to the doctor, an HDHP may be worth considering. Even though you will pay more if you experience a major medical emergency, an HDHP is infinitely better than not having any health insurance. Plus, choosing a higher deductible plan may save you money each month on premiums and give you the option to invest in the extremely powerful HSA.

Major medical needs can’t always be predicted, but some, like having a baby or opting for an elective surgery, can be. If you are generally healthy but will experience one of these events in a given year, it may be worth opting for a traditional insurance plan with better coverage, at least temporarily. The additional monthly cost may be worth the savings you get if you were to reach your deductible or out-of-pocket maximum. If you have medical conditions that require a great deal of care or are at an age where your medical expenses have increased significantly, a traditional health insurance plan may be the right choice for you.

How can I save money on health insurance?

Choosing the right type of health insurance plan for you and your family can help you save money by minimizing premiums, or if you have more medical expenses, maximizing the amount that insurance will cover. But insurance may still seem very expensive even after picking the right plan for you. Is there anything you can do about it?

Unfortunately we can’t fix the health insurance industry in the US, but you may have some options to make your plan more affordable. If you have health insurance through your employer and it isn’t working out for you or your family, try talking with your employer or HR to see if there is any possibility they may add additional health insurance options in the future. It may be worth looking at options outside of your employer and shopping around to see what else is available. Be wary of certain health share plans that aren’t actually insurance and aren’t subject to the same regulations. These plans can be less expensive, but aren’t legally required to pay claims and have other drawbacks such as limited or no coverage for preexisting conditions.

Make sure you know the ins and outs of what your plan covers so you know the best, and financially optimal, ways to seek the medical care you need. It may be cheaper to use a service like GoodRX to fill prescriptions instead of billing them through your insurance.

Nobody enjoys paying for medical insurance. Chances are you are paying for significantly more than you are receiving, but if you are one of the “lucky” ones who receives more benefits than they pay for, you are likely experiencing a major medical event and it’s pretty hard to be grateful for insurance coverage under those circumstances. No matter how much you dislike health insurance, you can’t go without it. Over 60% of personal bankruptcies are partially or totally caused by medical debt. Choosing the right health insurance plan for you and your family has the potential to save you money and give you access to super-powered tools like HSAs, but can also help put your mind at ease knowing an unexpected medical emergency won’t destroy your finances.

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