Takeaways
- HSAs let you contribute pre-tax dollars to healthcare expenses, reducing your tax liability.
- HSAs allow you to invest excess contributions into stock, bonds, and other investments.
- HSAs enjoy a triple tax advantage, which can help you save for rising medical costs.
- HSA accounts sometimes require a minimum deposit amount before you can invest funds.
- HSA funds roll over year to year, so your investments can enjoy compounding growth.
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A Health Savings Account (HSA) is a powerful tool for managing healthcare finances. It offers a triple tax advantage, allowing contributions to be made with pre-tax dollars, grow tax-free, and be withdrawn tax-free for qualified medical expenses. However, HSA funds can also be invested in long-term healthcare costs beyond saving for current needs. Let’s look at where to invest your HSA to maximize the benefit and discuss factors to consider when choosing a custodian.
Understanding HSAs
An HSA is a savings account offered with a high-deductible health plan (HDHP). HDHPs typically have lower monthly premiums (payments to keep your plan active) and higher deductibles (what you must pay out of pocket), meaning you pay more healthcare expenses before insurance kicks in to cover the remaining costs.
HSAs help offset these upfront costs by allowing you to contribute pre-tax dollars to pay for qualified medical expenses. These expenses include doctor visits, medical equipment, prescriptions, and even vision care.
Investing with Your HSA
Many HSA custodians offer investment options alongside the standard savings account. This allows your HSA funds to grow beyond what a standard savings account would offer. This growth is crucial, especially when considering rising healthcare costs.
According to a study by Fidelity Investments, healthcare costs have increased 6.5% per year over the past decade. With a typical savings account earning minimal interest, your HSA funds would struggle to keep pace with inflation, let alone grow for future needs. However, if you can invest in the S&P 500, which has earned an annualized growth rate of 10.91% over the last decade, you can meet and exceed the rising healthcare costs with your investing strategy [1].
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What is the Triple Tax Advantage?
HSAs' unique triple tax advantage sets them apart from regular savings accounts.
The first part of the tax advantage is that your HSA contributions are made with pre-tax dollars from your paycheck, reducing your annual taxable income. (Read more about the 2024 tax income brackets and rates)
The second critical advantage is that any growth on these investments within your HSA is tax-free. Additionally, unlike a Flexible Spending Account, your HSA savings roll over from year to year. This allows your investments to harness the power of compounding interest because as your gains increase, they build on themselves, allowing your investments to accelerate.
Finally, when you withdraw funds to pay for qualified medical expenses, those withdrawals are tax-free. Let's look at how this triple tax benefit works in action:
Imagine you earn $50,000 annually and contribute the maximum HSA contribution of $4,150 (individual) or $8,300 (family) for 2024 [2]. By contributing pre-tax dollars to your HSA, you effectively reduce your taxable income to $45,850 (individual) or $41,700 (family), lowering your tax liability in the current year.
Read More -> Best Online Tax Software Programs
Any investment earnings on your $3,850 or $7,750 contributions will grow tax-free. Of course, it is important to note that once your funds are deposited into your account, you must actually invest the funds. Instead of paying capital gains taxes on these funds if you buy and sell stocks, bonds, mutual funds, or other investments, your HSA funds grow unhindered by taxes.
Finally, when you have a medical expense and need to withdraw funds to cover a qualified expense, your withdrawals are also tax-free. This means you can access the full amount of your savings without any tax penalty.
This triple tax benefit makes HSAs a powerful tool for long-term healthcare savings
Preparing for Long-Term Care
Healthcare costs tend to increase as we age, and long-term care can be a significant expense. We all want to believe we will stay healthy but must plan for the alternative. To highlight the rising healthcare costs, a recent survey showed the national median annual cost for a private nursing home room could exceed $100,000 [3]. Investing in your HSA with a long-term view can accumulate significant savings to cover future costs. The tax advantages of HSAs make them ideal for saving towards long-term care needs, as the tax-free growth allows you to maximize your savings potential.
Since you can invest your HSA funds, you can easily work with a financial advisor or financial planner to strategize how these funds will augment your retirement savings. Investing in the right asset classes will catalyze your long-term success.
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Investment Options for Your HSA
When choosing where to invest your HSA, consider your risk tolerance and investment time horizon. Some HSA accounts will require a minimum deposit, say $1,000, in your HSA before you can invest any excess funds. Here's a breakdown of some common investment options offered by HSA custodians:
- Money Market Funds: These low-risk investments offer easy access to your cash and provide some interest on your balance. They are ideal for short-term needs or for those with a low-risk tolerance. Money market funds are a good option to park your HSA contributions while you decide on a long-term investment strategy.
- Bonds: Bonds can offer a more stable return than stocks but with less growth potential. They can be a good choice for those nearing retirement or if you have a more conservative investment disposition. The good news is that bonds can stabilize your HSA portfolio, especially as you approach retirement age, and may need easier access to your funds. (Read more about the 7 Different Types of Bonds)
- Stock Mutual Funds: Mutual funds offer a way to diversify your portfolio across multiple stocks. This reduces risk compared to investing in individual stocks. Stock mutual funds can offer significant growth potential and help diversify your portfolio, but they also carry more risk. This option suits those with a longer investment time horizon and a higher risk tolerance.
- Exchange-Traded Funds: Like mutual funds, ETFs offer diversification but may have lower fees than mutual funds. They can be a good option for those who want more control over their investments and allow you to trade in and out of ETFs throughout the trading day. ETFs provide a balance between diversification, lower fees, and liquidity.
- Target-Date Funds: They are often a type of mutual fund that automatically adjusts the asset allocation (mix of stocks, bonds, and cash) over time as you near retirement. This "set it and forget it" approach can be a good option if you are new to investing or don't want to actively manage your HSA portfolio.
Choosing the Right Custodian
Many companies offer HSAs through payroll deductions. If you have an HDHP, ask your Human Resources department about the HSA offering. If your company doesn't provide this option, you can open your own HSA. There are many variables to consider when opening an HSA with a custodian. As you evaluate your options, consider analyzing the following:
- Investment Options: Look for a custodian that offers a variety of investment options to match your risk tolerance and financial goals. As discussed earlier, consider options like money market funds, bonds, stock mutual funds, ETFs, and target-date funds.
- Fees: HSAs can have various fees, such as monthly maintenance fees, account setup fees, and investment fees. Compare fees between custodians to find one that offers a good value for your money.
- Ease of Use: Consider how easy it is to use the custodian's online platform and mobile app (if available) to manage your HSA and make investment decisions.
- Customer Service: Look for a custodian with a good reputation for customer service if you need help with your account or have any questions.
- Minimum Investment Amounts: Some custodians may have minimum investment amounts for certain options. Be sure to check these minimums before you open an account.
- Investment Advice: Not all HSA custodians offer investment advice. If you need help with investment decisions, consider choosing a custodian that offers robo-advisory services or access to financial advisors.
Tracking Your HSA Alongside Your IRA
While HSAs are primarily for medical expenses, they can also be valuable for long-term healthcare savings. Consider your overall retirement savings plan, including your Individual Retirement Accounts, when making investment decisions for your HSA. Here's how to think about this:
Tax Implications: IRAs offer different tax advantages depending on the type of IRA (Traditional vs. Roth). Traditional IRAs allow for pre-tax contributions with taxes deferred until withdrawal, while Roth IRAs allow for post-tax contributions with tax-free withdrawals in retirement. Understanding your IRA's tax implications will help determine how your HSA fits into your overall savings strategy.
Investment Options: IRAs typically offer a wider array of investment options than HSAs. Consider your overall asset allocation across your HSA and IRA to ensure a well-diversified portfolio.
Retirement Goals: HSAs can be a valuable tool for covering medical expenses in retirement. However, they shouldn't be your sole source of retirement income. Consider your overall retirement needs and how your HSA fits into the bigger picture.
Learn More -> Should You Max Out Your 401(k) Contributions?
Smart Summary
Mapping out your healthcare expenses is essential for creating a financial plan. Forecasting your expenses and planning for how you will keep up with the cost of medical expenses as you age will make you feel prepared. A health savings account can be an important piece of offsetting inflation and ensuring your savings are growing fast. With the wide latitude to invest your HSA contributions, you can accelerate your net worth by investing in growth-oriented assets while reducing the unpredictability of being able to handle future medical bills.
(1) S&P Global. S&P 500: April 29, 2014 to April 29, 2024. Last Accessed April 29, 2024.
(2) Internal Revenue Service. Publication 969 (2023), Health Savings Accounts and Other Tax-Favored Health Plans. Last Accessed April 29, 2024.
(3) Genworth. Cost of Care Trends & Insights. Last Accessed April 29, 2024.
