Maximizing Your Health Savings Account (HSA)
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by Alvin Yam, CFP®
- Updated
Health Savings Accounts stand out as the only type of account that offers triple tax advantages. And this unique feature makes HSAs an incredibly powerful tool for wealth building.
But only 9.3% of Americans own an HSA.
If you want to build wealth while also covering future medical expenses, understanding how to use an HSA is a game changer.
1. What Are HSAs?
Health Savings Accounts (HSAs) are one of the best-kept secrets in personal finance.
A Health Savings Account (HSA) is a special type of savings account designed to help save for future medical expenses. HSAs were introduced in late 2003 and have since become a popular financial tool for millions, especially for those with high deductible health plans (HDHPs).
What makes HSAs unique is their triple tax advantage:
HSAs are the only type of account that offers triple tax advantages which make them even better than traditional retirement accounts such as an IRA (individual retirement account).
- Contributions are tax-deductible: The money you contribute to an HSA reduces your taxable income.
- Investment growth is tax-deferred: Any growth or interest earned on your HSA balance is not subject to taxes.
- Withdrawals for qualified medical expenses are tax-free: When you use HSA funds for eligible medical expenses, you won’t pay any taxes on those withdrawals.
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2. Who‘s Eligible to Open an HSA
To qualify for an HSA, you have to be enrolled in an HDHP and not have any other health coverage that pays for out-of-pocket medical expenses before the deductible is met.
This means that you’ll need to first pay a higher amount out of pocket for medical expenses before your insurance coverage begins to kick in.
But in exchange, you get the ability to contribute to an HSA.
A high-deductible health plan (HDHP) is a type of health insurance which have lower monthly premiums, but higher deductibles compared to traditional plans.
Expert Tip
Don’t choose an HDHP solely to get an HSA if you have frequent medical needs. The higher out-of-pocket costs might outweigh the benefits of the HSA.
3. Why Get an HSA?
An HSA isn’t just a savings account. If used strategically, it’s a powerful wealth-building tool.
That’s because:
- Contributions to an HSA reduce your taxable income, and any growth or withdrawals for qualified medical expenses are tax-free.
- HSAs can be used as a supplementary retirement account. After age 65, you can withdraw funds for any purpose without the 20% penalty (though non-medical withdrawals will be taxed as income).
- HDHPs typically have lower premiums than traditional health insurance plans, saving you money.
Expert Tip
While you won’t incur a penalty for non-medical withdrawals after age 65, the amount withdrawn will be taxed as regular income. This means that if you take out funds for non-qualified expenses, you must report these withdrawals as income when filing your taxes, which could increase your overall tax liability.
Maximize your HSA contributions each year to take full advantage of the tax benefits and grow your retirement savings.
4. What Are the Contribution Limits?
For 2024, the contribution limits for Health Savings Accounts (HSAs) are:
Coverage Type | 2024 Contribution Limit | Catch-Up Contribution (Age 55+) |
Individual Coverage | $4,150 | $1,000 |
Family Coverage | $8,300 | $1,000 |
In 2025, you can contribute up to $4,300 if you have health coverage just for yourself or $8,550 if you have coverage for your family.
While you can open multiple Health Savings Accounts (HSAs), the contribution limits apply to the total amount across all accounts.
Max out your HSA contributions each year to maximize your tax benefits and your savings.
5. Where Do You Get an HSA?
Finding the right place to open an HSA depends on your employment status, but here are your typical options.
1. Through Your Employer:
Many employers offer HSAs as part of their benefits package and let you contribute to the Health Savings Account directly from your paycheck through pre-tax payroll deductions.
The benefit of your contributions made through payroll deductions is that these aren’t subject to federal income tax, Social Security tax (FICA), or Medicare tax.
For example, contributing $3,000 to your HSA decreases your taxable income by the same amount, which could potentially put you in a lower tax bracket.
You can also make additional contributions directly to your HSA from personal funds and claim them as tax deductions when filing your tax return.
2. Through Your Health Insurance Provider
Some health insurance companies that offer HDHPs also provide HSA options. When you enroll in their HDHP, they might help you open an HSA.
3. At a Bank, Credit Union, or Investment Platform:
If your employer or health insurer doesn’t offer an HSA, you can open one at a bank, credit union, or investment platform.
You’ll need to fund the account with after-tax dollars, but contributions can be claimed as tax deductions when you file your taxes.
Expert Tip
When deciding which institution to open your HSA, look for accounts with low or no maintenance fees and no minimum balance requirements.
Why do we use it?
6. Qualified Medical Expenses
To get the most out of your HSA, know what counts as a qualified medical expense.
The IRS defines certain medical expenses as “qualified,” meaning you can use your HSA funds to pay for them without incurring taxes or penalties.
Here are some examples:
- Flu shots
- Ambulance services
- Physical therapy
- Prescription drugs
- Eyeglasses (both prescription and reading)
- Doctor’s office visits and co-pays
7. Withdrawing Money for Non-Qualified Expenses
What if you use HSA funds for non-qualified expenses?
If you withdraw HSA funds for non-qualified expenses before you turn 65, you will face the following:
- The amount withdrawn will be subject to federal income tax. This means you’ll need to report the withdrawal as income when you file your tax return, which could increase your overall taxes owed.
- You’ll also need to pay a 20% penalty on the amount withdrawn.
Let’s say you withdraw $1,000 for a non-qualified expense before age 65. You’ll then owe taxes on that amount based on your income tax rate. On top of this, you’ll pay a $200 penalty.
Exception After Age 65
Once you reach age 65, the rules change. You’re allowed to withdraw HSA funds for any purpose without facing the 20% penalty.
But if the funds are used for non-qualified expenses, you’ll still owe income tax on the amount withdrawn.
The HSA Loophole
After you turn 65, the rules change in your favor. Once you reach age 65, you can use your HSA funds for any purpose without incurring the 20% penalty.
However, keep in mind that non-qualified withdrawals will still be subject to income taxes.
Expert Tip
Avoid using your HSA funds for non-qualified expenses unless you’re over 65. This way, you can avoid the 20% penalty.
8. Your Supplementary Retirement Account
One of the best features of Health Savings Accounts is the ability to invest your funds and let them grow without any time constraints.
Unlike other tax-advantaged accounts, such as 401(k) plans and traditional IRAs, HSAs don’t have required minimum distributions (RMDs) that force you to withdraw funds at a certain age.
With an HSA, you can invest the money and allow it to grow for as long as you want. This flexibility is a game changer for investors who want to maximize their long-term savings and let their investments compound over time.
Investing Your Contributions
Keep in mind that you’re able to invest the funds in your HSA rather than keeping them in cash.
This opens up opportunities:
- You can invest money before taxes are taken out, and you’re able to maximize your growth potential. Since the IRS does not tax the growth in your HSA, you can use this as a powerful tool to build wealth.
- Your investments can grow without being subject to taxes on gains, allowing you to build your savings and wealth faster.
- When you withdraw funds for qualified medical expenses, you can do so tax-free, including any investment gains.
Here’s how investing in your HSA works:
- Most HSAs require that the first $1,000 remains in cash or cash-equivalent accounts to ensure that you have access to funds for short-term medical expenses.
- Once your balance exceeds $1,000, you can invest additional contributions in a variety of options, including mutual funds, exchange-traded funds (ETFs), or bonds.
- When deciding how to allocate your funds, consider your risk tolerance and investment objectives. If you are younger and have a longer time horizon until retirement, you should opt for more aggressive investments.
Potential Growth Over Time
For 2024, the maximum contribution limits are $4,150 for individuals and $8,300 for families. Let’s say you consistently invest the maximum amount each year and earn an average annual return of 7%.
Here’s what your HSA could grow to if you keep your contributions invested for 40 years:
- For Individuals: If you invest the maximum annual contribution of $4,150, with a 7% annual return, you could grow your HSA to $880,048 by the time you reach retirement age.
- For Families: If you invest the maximum family contribution of $8,300 annually, you could grow your HSA to $1,771,526 over the same 40-year period.
Expert Tip
When opening an HSA, look for institutions that offer a wide range of investment choices, such as exchange-traded funds (ETFs) and mutual funds. Fidelity offers an HSA account where you can manage your investments, which include stocks, bonds, ETFs, and mutual funds.
Regularly review and rebalance your HSA investments to see that they align with your long-term financial goals.
9. Using Your HSA to Maximize Savings and Rewards
A lesser-known benefit of HSAs is the opportunity to boost your savings and earn rewards.
Pay for Qualified Medical Expenses Using a Credit Card and Collect Points
One effective strategy is to use a rewards credit card to pay for your qualified medical expenses. By doing this, you can earn cash back, points, or other rewards on your spending. This approach allows you to benefit from your regular expenses while keeping your HSA funds intact for future use.
HSAs allow you to reimburse yourself for qualified medical expenses at a later date. You can pay for these expenses out of pocket initially, allowing your HSA funds to grow untouched.
When you’re ready, withdraw the amount from your HSA tax-free, as long as you have the receipts.
The Bottom Line
HSAs are more than just a savings account — they're a powerful tool for tax savings, wealth building, and retirement planning. If you qualify, opening an HSA should be a top priority.
FAQs
A health savings account (HSA) is a tax-advantaged account that allows you to save and invest money for future medical expenses. It offers triple tax benefits: tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified medical expenses.
To be eligible for an HSA, you must be enrolled in a high-deductible health plan (HDHP), have no other health coverage, not be enrolled in Medicare, and not be claimed as a dependent on someone else’s tax return.
For 2024, the contribution limits are $4,150 for individual coverage and $8,300 for family coverage. Individuals aged 55 and older can make an additional $1,000 catch-up contribution.
You can open an HSA through your employer, health insurance provider, or at a bank, credit union, or investment platform. Look for accounts with low fees and no minimum balance requirements.
Qualified medical expenses include doctor visits, prescription drugs, dental care, vision care, and more. The IRS defines which expenses are eligible.
If you withdraw funds for non-qualified expenses before age 65, the amount will be subject to income tax and a 20% penalty. After age 65, you can withdraw funds for any purpose without the penalty, but non-qualified withdrawals will still be taxed as income.
Yes, once your HSA balance exceeds a certain threshold (typically $1,000 to $2,000), you can invest the funds in mutual funds, ETFs, stocks, and bonds. Investing allows your HSA to grow tax-deferred and tax-free for qualified medical expenses.
To maximize the benefits, contribute the maximum amount each year, invest the funds for long-term growth, and use a rewards credit card to pay for qualified expenses while reimbursing yourself later from your HSA.
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Expert Tip
Don’t choose an HDHP solely to get an HSA if you have frequent medical needs. The higher out-of-pocket costs might outweigh the benefits of the HSA.
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