Should You Spend or Invest Your HSA Funds?
Understand the many benefits of using a health savings account (HSA) and whether it’s better to spend your balance on medical costs or keep it invested for the long term.
Inu says, “I’ve heard your recent podcast about using an HSA and still have a question. I invest most of my HSA money in mutual funds, so taking money out means it loses investment growth. I’m wondering if it’s better to spend my HSA funds, or to just pay my medical expenses out of pocket when I can afford them, to keep the account growing?”
Thanks for your great question, Inu! In this post, I’ll review the benefits you get from using a health savings account (HSA) and whether it’s better to spend your balance on medical costs or keep it invested for the long term.
Triple Tax Benefits of Using an HSA
An HSA is a special type of account that you can set up for the sole purpose of paying qualified medical expenses, such as deductibles and out-of-pocket costs, on a pretax basis now or at any time in the future. You can contribute to one only if you have an eligible high-deductible health plan through an employer or as an individual.
An HSA offers three money-saving tax benefits.
1. Your HSA contributions are never taxed.
An HSA is funded with pre-tax dollars, whether you make contributions or your employer does so on your behalf. If you fund the account on your own, you claim total annual contributions as a deduction on your taxes (even if you don’t itemize deductions). If an employer makes your contributions, they’re deducted from your paycheck before taxes are taken out.
You can make tax-deductible contributions to an HSA at any time during the year, even up to April 15 for the previous tax year.
You can make tax-deductible contributions to an HSA at any time during the year, even up to April 15 for the previous tax year. You can contribute even if you’re retired, unemployed, or have annual income less than your contributions. And you’re never required to make HSA contributions.
For 2018, you or your employer can contribute a total of up to $3,450 to an HSA if you have insurance just for yourself, or $6,900 if you have a family plan. (The family limit was recently increased $50 from $6,850 due to a correction in the inflation adjustment calculations for the year.)
If you’re age 55 or older you or your employer can contribute an additional $1,000 to an HSA when you have either an individual or a family health plan.
2. Your HSA earnings are never taxed.
Most HSAs pay interest on your balance, just like a bank savings account. Plus, you typically also have the option to transfer all or a portion of your HSA to investments, such as mutual funds, to grow your balance.
Unlike with a taxable bank or brokerage account, interest or investment growth in an HSA is completely tax free.
3. Your HSA withdrawals are never taxed.
When you take money out of an HSA, there are no taxes. This is true no matter if you withdraw original contributions, interest income, or investment earnings from the account to pay for qualified healthcare expenses.
This can be more beneficial than taking money out of a retirement account, such as a traditional IRA or 401k, which do require you to pay income tax on withdrawals. An HSA even has more advantages than a Roth retirement account, which also allows tax-free withdrawals—but requires tax on your contributions.
Just like with a retirement account, you should never put money in an HSA that you might need for everyday expenses. You can only use HSA funds to pay for current or future qualified, unreimbursed medical expenses. Otherwise withdrawals are subject to income tax plus a hefty 20% penalty.
You’re never required to take withdrawals from an HSA. Your balance can stay in the account indefinitely and even be passed to your heirs.
An HSA is portable, which means you can take it with you if you switch employers or retire. You can continue spending it, even if you no longer have a high-deductible health plan or you become unemployed.