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David Gardner
Sr. Wealth Advisor, Director
Nearly 20 years after their debut, HSAs offer much more than just the ability to pay medical bills with pre-tax dollars.
Consumers held roughly $100 billion in health savings account (HSA) wealth at the beginning of 2022.1 The number will surely grow in the years ahead because investors are figuring out that HSAs not only offer a practical way of setting aside money for future medical expenses, but also have generous tax advantages that allow for long-term tax-free growth. As a result, what started out as a relatively staid way of setting aside funds in an interest-bearing account for future healthcare costs has morphed into a legitimate investment category of its own.
Established in law by President George W. Bush’s Medicare Prescription Drug, Improvement, and Modernization Act of 2003, the HSA emerged as a tax-advantaged account designed to pay for medical expenses. Qualified expenses include visits to a doctor or dentist, prescription drugs, eyeglasses, medical equipment and supplies, and medical services such as home care. Physical therapy, quit-smoking programs, psychological counseling, and hearing aids are also covered. Vitamins, toiletries, over-the-counter medicines, and childcare (for healthy babies or children) are not qualified HSA expenses.
Expense | Qualified or Nonqualified |
Medicare premiums | Qualified |
Expenses reimbursed from other sources (such as a flexible spending account) | Nonqualified |
Cosmetic surgery not related to trauma or disease | Nonqualified |
Dental treatment | Qualified |
Hearing aids | Qualified |
Vitamins | Nonqualified |
HSAs may be the only account available that has four significant tax advantages:
In my experience, most people with an HSA tend to fund it largely through employer contributions, and use the funds throughout the year to pay for deductibles, prescriptions, and other medical costs. They max out the annual contribution and use a debit card to pay expenses. This way of thinking probably carries over from flexible spending accounts (FSAs) that have a “use it or lose it” provision—if FSA funds aren’t used by March 15 of the following year, the remaining balance is forfeited. HSAs have never had this provision; it’s always been allowable to carry the balance of an HSA from one year to the next. As the funds grow tax-free year after year, HSAs have proved handy for preparing for one-time unexpected expenses.
What’s changed during the two decades since their inception is that more investment companies have become involved in HSA management, helping to drive down costs and increase investment options. It’s now possible to invest in low-cost diversified mutual funds and exchange-traded funds. Plus, because HSAs have been available for 20 years, balances have grown. For example, instead of drawing down our HSA balance each year, my family focuses on building this asset that, if used correctly, will give us tax-free growth over our lifetimes. An analogy is that the HSA is like a Roth IRA that offers an up-front income and employment tax deduction—in other words, you can have your tax cake and eat it too.
If you still have money in an HSA after you turn 65, you can spend the money however you want, without penalty. However, if the spending is not for qualified expenses, you won’t be penalized but you’ll be taxed at your current income tax rate.3
If you’re covered by a qualifying HDHP, then you and your employer combined can put aside up to $3,650 in 2022 for a one-person plan, and up to $7,300 for a family. Catch-up contributions of an additional $1,000 are allowable for those who turn 55 or older this year.
Another less-known aspect of HSAs is that you can supplement the employer contribution with your own income to reach the $3,650 and $7,300 maximums. Very rarely will employers max out the annual contribution. The easiest method for most employees is to use the same account their employer has set up for its deposits. With a single HSA provider, the employer can monitor the maximum annual contribution to ensure that an employee doesn’t exceed the limit. Plus, by using payroll deductions, employees can avoid Social Security and Medicare taxes on those deferred wages.
There’s still time in 2022 to boost your contributions to the maximum. If you still have room in your HSA contribution limit after the year is over, the IRS gives you until April 15 of the following year to make contributions directly from your bank account.
If you can’t tell by now, I am a huge fan of HSAs as an investment vehicle. Given their multiple tax advantages, I encourage people to maximize contributions every year and invest for the long term once they have enough cash set aside to cover a medical emergency. For many who have their emergency fund in place and are contributing enough to receive a retirement plan match, one of their next priorities should be making a full contribution to an HSA if enrolled in a qualifying health insurance plan.
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