According to the CDC, in 2017, 43% of adults who get their health insurance through their employers had high-deductible health plans (HDHP), and 19% had HDHP plans coupled with a health savings account (HSA). In just 10 years from 2007 to 2017, the number of Americans with HDHPs increased 3x, and the number with HDHPs coupled with HSAs increased 4x. These numbers are only going to keep increasing as employers push the burden of health coverage decisions to employees (just as they have done with retirement plans over the past several decades).
If you have a HDHP with an HSA, there are several things you should consider to maximize your HSA account:
1) If your employer makes a contribution to your HSA but conditions the contribution on your taking specified actions (e.g. getting a physical, doing a biometric exam), make sure you do it. Don’t pass up free money.
2) You should contribute as much as you can afford into your HSA up to the maximum amount (for 2019, $3500 for single, $7000 for family, 55+ can contribute an additional $1000).
3) HSAs are triple tax-advantaged. First, contributions you make into your HSA account are deducted through payroll using pre-tax money (except for CA and NJ, which do not recognize HSA contributions for state income tax purposes). Second, the funds in your HSA grow tax free (except for CA and NJ; NH and TN residents also have to follow different rules). If your HSA funds are in a bank account, as most are, you won’t be taxed on any earned interest; if your HSA funds are invested in stocks, bonds and mutual funds, you won’t be taxed on any dividends, capital gains or interest). Third, your HSA funds are not taxed if used for qualified medical purposes (unlike a 401k which only defers taxes until you start to withdraw money in retirement).
4) Investing. Under most HSA accounts, you do not have to stick with the default bank savings account and can invest your funds in investments offered by your HSA administrator. Given the tax-advantaged nature of HSAs, the HSA is an opportune place to put your investments with high expected returns (e.g. stocks) and/or tax-inefficient investments (e.g. REITs, bonds). Rather than thinking about your HSA as a separate fund for medical expenses, when you’re investing your HSA funds, you should take into account your overall asset allocation. If your company-selected HSA custodian only offers unattractive investments (i.e. investments that don’t fit into your asset allocation strategy and/or are high-expense funds), more than likely, your HSA plan will allow you to move your funds to another HSA custodian. The Money Blawg is a big fan of Fidelity’s free HSA, where you can select from a huge number of low-cost or even free index funds.
5) Pay for Medical Expenses Out-of-Pocket (if you can). Despite your HSA having the word “Health” in it, you don’t have to prioritize paying medical expenses from your HSA first. If you can afford it (and that can be a big IF), pay for your medical expenses out-of-pocket. The reason is simple: funds that are invested in your HSA are growing tax-free, and the more time you can keep those funds invested, the more they will grow tax-free. Eventually, everyone ages, gets ill and/or incurs healthcare expenses, so these funds will be spent – you’re just giving them a chance to grow in a tax-advantaged account for as long as possible.
6) Save Your Medical Expense Receipts. If you’re paying for your medical expenses out-of-pocket, save the receipts you get from the doctor’s office. pharmacy, Amazon, etc. You can always seek reimbursement from your HSA for those expenses later (after your HSA has had time to grow and compound tax-free), but your HSA administrator will need proof. If you hate keeping paper receipts, scan or take a picture of them.
7) Paying for Medical Expenses from Your HSA is OK. Notwithstanding the above, paying for some or all of your medical expenses with your HSA funds is a perfectly fine thing to do, particularly if you have medical expenses that make it hard to pay out-of-pocket. There’s still a huge benefit to using pre-tax dollars versus not contributing funds into an HSA as well.
8) HSAs are NOT “Use It This Year or Lose It”. Some people get HSAs confused with Flexible Spending Accounts. You do NOT have to use up all the funds in your HSA within the plan year. Amounts that are not used and that stay invested will continue to grow tax-free.
9) Supercharge Your Retirement Savings. For the super-savers out there who have maxed out their other retirement accounts, the HSA can be another tool for additional tax-advantaged retirement saving. Once you reach age 65, you can withdraw money for non-medical purposes, and your HSA will be treated like a Traditional IRA where your earnings are taxed at ordinary income tax rates. You won’t pay a 20% penalty like you would if you are under 65 and try to use HSA funds for non-medical expenses. However, using the accumulated funds for medical expenses will still be the best way to maximize the use of those funds.
10) California and New Jersey Residents. Even though California and New Jersey don’t recognize HSAs for state income tax purposes, it still makes sense to contribute to your HSA as much as you can to get the federal tax break. If you want to minimize the headache of tracking cost basis, dividends and interest for your investments (your HSA administrator will not do this for you like your brokerage would), you can invest your money in investments that are not taxable at the state level, such as US treasury securities.
