Money Girl

3 Smart Strategies for Using a Health Savings Account

Episode Summary

Understand the benefits of a health savings account (HSA), who qualifies to have one, and whether you should spend it or keep it invested for the long term.

Episode Notes

Laura breaks down the benefits of a health savings account (HSA), who qualifies to have one, and whether you should spend it or keep it invested for the long term.

Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.

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Episode Transcription

Hello, friends, and thanks for joining me this week! My name is Laura Adams, and I'm a personal finance expert who's been hosting the Money Girl Podcast since 2008. 

I'm also the author of several books, including my most recent title, a No. 1 Amazon New Release called Money-Smart Solopreneur–A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. If you're building a business or want to earn more income on the side, I hope you'll grab a copy of the paperback, ebook, or audiobook today!

My mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress. I create every show to make sure you come away with practical advice that helps you make better money decisions and takes your financial life to the next level.

Be sure to subscribe to the show and participate by sending me your money questions or comments. You can email me using my contact page at LauraDAdams.com or connect on Instagram at lauradadams. You can leave a message 24/7 on our voicemail line at 302-364-0308.

Today's episode is number 730, called 3 Smart Strategies for Using a Health Savings Account.

I've had a health saving account or HSA for as long as I can remember. Because an HSA offers so many tax benefits and extra flexibility in retirement, it might be my favorite tax-advantaged account. 

A common question I hear is whether you should spend HSA funds or keep them invested and growing. In this podcast, I'll review HSA benefits and discuss whether it's better to spend your balance on qualified medical expenses or keep it invested for the long term.

First, here's a quick review. An HSA is a medical savings account you can use to pay certain healthcare costs, such as deductibles and out-of-pocket expenses, tax-free. However, you must have a high-deductible, HSA-qualified health plan to qualify. You might get it through a group health plan at work or buy it as an individual.

An HSA offers three powerful money-saving tax benefits:

1. Your contributions are never taxed.

You fund an HSA with pretax dollars, giving you a nice tax deduction, even if you don't itemize them on your tax return. You can make HSA contributions any time during the year, even up to April 15 for the previous tax year. 

You can contribute to an HSA if you're retired, unemployed, or have an annual income less than your contributions. But you're never required to make HSA contributions.

For 2022, you, your employer, or your family can contribute up to $3,650 if you have insurance for just yourself or up to $7,300 for a family plan. Plus, there's an annual "catch-up" contribution of $1,000 for those over age 55.

2. Your investment earnings are never taxed.

Most HSAs pay interest on your balance, like bank savings. You can typically transfer all or a portion of your balance to investments, such as mutual funds. Unlike a taxable bank or brokerage account, your interest and investment growth in an HSA is entirely tax-free. That's pretty nice!

3. Your withdrawals are never taxed.

When you make HSA withdrawals of original contributions and earnings to spend on qualified healthcare expenses, they're completely tax-free. That's an even better deal than traditional retirement account withdrawals, which get taxed. An HSA even beats a Roth retirement account, which allows tax-free withdrawals, but requires you to pay tax upfront on contributions.

However, you should never put money in an HSA that you might need for everyday expenses, like rent or groceries. You can only use the funds for current or future qualified, unreimbursed medical expenses. You're subject to income tax plus a hefty 20% penalty on non-qualified withdrawals.

To learn more about the wide range of healthcare costs you can pay for using an HSA, check out podcast number 701, called Your Guide to Saving Money with an HSA Now and in Retirement.

In addition to its triple tax advantages, there are even more benefits you get from using an HSA. 

Because an HSA offers so many benefits now and in retirement, you may wonder if spending the funds or keeping them invested and growing year after year is better. Here are three smart strategies for using your HSA:

Strategy number one is to make tax-free HSA withdrawals to pay current medical expenses.

Most HSAs give you a debit card to pay for eligible medical costs in real-time. That's the traditional and most popular way to use an HSA, especially if you don't have other savings to pay healthcare expenses.

Strategy number two is to pay medical costs out-of-pocket and make HSA withdrawals in the future to reimburse yourself.

HSA rules don't require you to pay qualified expenses within a certain period. So, if you have the cash to pay them or want to put them on a credit card, you can reimburse yourself later from the account. 

This method is known as "shoeboxing" your HSA, which creates an IOU to yourself that you redeem when you like. Just be sure to keep good records to verify your qualified expenses. Also, note that you can't use HSA funds to pay costs you incurred before opening the account.

Strategy number three is to pay medical expenses out-of-pocket with no HSA reimbursement.

HSA rules don't require you to reimburse yourself for qualified medical expenses. You can opt not to make any account withdrawals and keep the money growing tax-free in the account. Or you might choose to pay small healthcare expenses out of pocket and reserve your HSA for high or unexpected qualified costs. 

So, whether you should spend your HSA or keep it invested depends on your account and financial situation. While HSAs come loaded with tax benefits, they offer less flexibility than a retirement plan because they're strictly for healthcare costs. Also, they're not known for providing best-in-class investments with low fees, which can erode their net investment returns.

However, if you invest most of your HSA balance in diversified funds, some might argue that it's better not to spend it. In other words, if you can afford not to tap your HSA, that gives you maximum tax savings. 

But if your HSA funds are not invested or earn little interest, you'll likely come out ahead by spending them on qualified medical expenses. That gives you guaranteed tax savings, which could be more than 30%, depending on your income and tax rate. Finding an investment to beat that return would be difficult!

But it's possible that letting your HSA stay invested for decades could be more valuable with compounding interest. It depends on your investment return and how long the account stays invested.

Here's how I use my HSA. I make monthly contributions in amounts that max out the account by the end of the year. Every month, I sweep amounts that exceed $1,000 into growth-oriented investments.

My husband and I generally use our HSA to pay qualified expenses as we go. Paying for them with pretax money is an immediate benefit that I don't believe I could beat by leaving the account untapped. I can't know which option is right for you, but the good news is that any strategy you choose to use an HSA saves money and is a huge win.

If you qualify for an HSA, they're available at many banks, credit unions, brokerages, and specialty institutions. Shop around to find one that gives you diversified investment options, low fees, and a convenient online experience. 

Before we go, I want to invite you to connect with me on Twitter @lauraadams or Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.

That's all for now. I'll talk to you next week. Until then, here's to living a richer life!