Key Points

• A health savings account (HSA) is a type of tax-advantaged savings account  that can help reduce the burden of higher out-of-pocket medical expenses for individuals and families with high-deductible health plans (HDHPs)

• HSAs are vastly underutilized for retirement purposes — only 9% of HSA account holders are investing their funds

• HSAs are triple tax-advantaged: contributions are tax-deductible, contributions can be invested and grow tax-free, and distributions are not taxed (when used for qualified medical expenses)

Health Savings Accounts (HSAs) are one of the most underutilized retirement saving options.

According to a 2023 Employee Benefit Research Institute® study, while more people are using HSAs, they’re not taking advantage of its investment ability. Only 12% of accountholders were invested in assets other than cash. Contributions were below maximum allowances, withdrawals were high, and balances remained low. It seems people understand their value in paying for medical expenses. What many don’t realize is they can also be harnessed to strategically save for retirement.

For healthy individuals with low medical costs, Capstone often recommends using an HSA account as part of a longer-term investment plan. Let’s dive into how HSAs work, why they’re a great option for retirement saving, and how they can be best maximized.

What Is an HSA?

HSAs are pre-tax savings accounts that can be used for qualifying medical expenses — such as prescriptions, copays, over-the-counter medicines, and dental and vision care. In order to contribute to an HSA, individuals or families must be covered by high-deductible health plans (HDHPs). HDHPs are plans that have a deductible of at least $1,500 and maximum out-of-pocket of $7,500 for self-only coverage, or a deductible of at least $3,000 and maximum out-of-pocket of $15,000 for family coverage (as of 2023).

Once the HSA account is funded, it can be used at any time to pay for medical expenses — even if the accountholder no longer is enrolled in an HDHP Plan. The only requirement is that the expense had to be incurred after the HSA was established. 

How Are HSAs Funded?

Contributions to HSAs are typically made by the account holder via automatic pre-tax payroll deductions. Additional direct tax-deductible contributions can be made for a given tax year up until the filing deadline of that tax year (typically April 15th of the following year). 

Employers can also make contributions to employee HSA accounts, and many do so in order to increase the appeal of HDHPs to their employees. According to UpCounsel, the average employer contribution for a single employee is $750, and $1,200 for an employee with a family.

There is an annual limit on contributions made by both the employee and the employers. For 2023, the total contribution limit was just raised to $3,850 per individual and $7,750 per family. For account owners aged 55 and older, an additional $1,000 catch-up contribution can be made.

HSAs vs. FSAs: What’s the difference?

While HSAs and Flexible Spending Accounts (FSAs) both allow individuals to set aside pre-tax savings for qualifying medical expenses, they have several key differences.

For one, unused HSA funds can accumulate over time and can be used later, either for qualifying medical expenses or for retirement costs after age 65. In contrast, FSA funds must be used by the end of each year, and any remaining funds are returned to the employer.

Another key difference is that FSAs can be funded and used in tandem with almost all health insurance plan types, while HSAs can only be contributed to when the individual is covered by an HDHP.

Benefits of HSAs

HSAs are a flexible savings vehicle that can be used for both short-term and long-term costs. Let’s take a look at several of their key benefits:

Managing Rising Healthcare Costs

Healthcare costs continue to increase with inflation — this year, they’re expected to increase by 5.4%. And according to the 2022 Fidelity Retiree Health Care Cost Estimate, the average retired couple at age 65 will spend around $315,000 on health care expenses.

With this in mind, setting aside money in an HSA is a great way for individuals to prepare for higher medical costs in the future.

Strategic Retirement Planning

HSAs can be a very powerful tool for long-term retirement planning. Individuals who currently don’t have high medical expenses — and are thus able to avoid spending their entire yearly contributions — can rapidly accumulate their funds by investing them in mutual funds, ETFs, or even individual stocks and bonds. If HSA funds end up exceeding medical expense needs, at age 65 the HSA account owner can begin to use their savings for nonmedical expenses — similar to how they would use savings in a 401(k) or IRA account. Distributions for nonmedical expenses after 65 are taxable but avoid the 20% penalty that is imposed on nonmedical expense withdrawals taken before age 65.

Triple Tax Advantage = Maximum Savings

HSAs are the only investment account option that offers three tax advantages:

• Contributions are Tax Deductible: Contributions made to an HSA — either through payroll deductions or direct account contributions — will reduce income subject to federal tax and most state taxes.
  
  A unique advantage of HSA contributions made through payroll is that they are not subject to the Federal Insurance Contributions Act (FICA) tax of 7.65% that’s deducted from employer paychecks. This means that individuals who make HSA contributions through payroll deductions receive an extra layer of tax savings.

•  Contributions and Earnings Grow Tax-Free: Unlike a typical savings or brokerage account, investment income and gains recognized in an HSA are not subject to taxes.

• Tax-free Withdrawals: Any withdrawals that are made for qualifying out-of-pocket medical costs will not be taxed.

Should I Use an HSA to Save for Retirement?

If you’re in good health and looking to boost your retirement savings, then an HSA plan could be of tremendous benefit.

Let’s assume you contribute $3,850 per year to your HSA starting at age 30. With a 7% growth rate, that would result in an account balance of about $570k at age 65! And none of that would be taxed. Of course, to see numbers like this you would need to avoid paying for medical expenses with your HSA account so that funds can compound.

If you are eligible to contribute to an HSA account because you have an HDHP, we almost always recommend doing so. The question to ask yourself is — do the benefits of contributing to an HSA outweigh the higher potential out-of-pocket costs associated with HDHP coverage? If you’re younger, have fewer medical expenses, and are interested in using your account strategically to save for the long term, then the answer is likely yes.

Disclosures:

This article is not a substitute for personalized advice from Capstone and nothing contained in this presentation is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed by other businesses and activities of Capstone. Descriptions of Capstone’s process and strategies are based on general practice, and we may make exceptions in specific cases. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.