Inaya Mclaughlin
A health savings account (HSA) is a great way to save for future medical expenses or boost your retirement funds. HSAs are available to those with a high-deductible health insurance plan, and they come with a triple tax benefit: contributions are tax-deductible, earnings remain tax-free, and withdrawals are not taxed when used for qualified medical expenses. Investing your HSA funds is a great way to take advantage of the account's benefits, and there are several options for doing so. You can choose to invest in stocks, mutual funds, ETFs, or other types of funds, depending on your risk tolerance and future medical needs. Additionally, some HSA providers offer the option of using a robo-advisor, which selects investments on your behalf based on your answers to questions about your financial goals and risk tolerance. By investing your HSA funds, you can make the most of this tax-advantaged account and work towards securing your financial future.
| Characteristics | Values |
|---|---|
| Tax benefits | Contributions are tax-deductible, earnings accumulate tax-free, and withdrawals are not subject to federal income tax when used for qualified medical expenses. |
| Investment options | Stocks, bonds, mutual funds, ETFs, dividend funds, index funds, robo-advisors, and more. |
| Eligibility | Available if you have a high-deductible health insurance plan. |
| Contribution limits | $4,150 for individuals and $8,300 for families in 2024. Individuals aged 55+ can contribute an additional $1,000. |
| Rollovers | HSA funds can be rolled over from year to year and can also be rolled over from certain other accounts, such as IRAs. |
| Withdrawals | Withdrawals for qualified medical expenses are tax-free. Withdrawals for non-qualified expenses are subject to income tax and a 20% penalty before age 65. After age 65, the penalty is removed. |
| Fees | Some HSA providers may charge annual asset-based fees, transaction fees, or internal fund expenses. |
| Cash target | It is recommended to keep a "cash target" in your HSA to cover near-term expenses. This is typically equal to your expected annual out-of-pocket medical expenses or your in-network deductible amount. |
What You'll Learn
Understanding the triple tax advantage
Health Savings Accounts (HSAs) are a great way to save for future medical expenses and offer triple tax benefits. These benefits are:
- Tax-free contributions: HSA contributions are not taxed. This is similar to a traditional 401(k) or IRA. The IRS has set a limit on how much someone can contribute to an HSA each year. For 2024, the maximum contribution limit is $4,150 for an individual and $8,300 for a family. Those aged 55 and older can contribute an additional $1,000 annually. Contributions can be made through payroll deductions, which are also not subject to Social Security or Medicare taxes.
- Tax-free growth: Accountholders can grow their funds through interest and investing, and this growth is not subject to taxes. There is no expiration date on an HSA, and no minimum required distribution, meaning accountholders can spend years growing their funds tax-free.
- Tax-free distributions: Funds spent from an HSA are not taxed as long as they are spent on qualified medical expenses. These include deductibles, copays, prescriptions, vision, and dental care. If HSA funds are used for non-qualified medical expenses, taxes and an additional 20% penalty will be incurred. However, once the accountholder reaches age 65, HSA funds can be used for any reason, although taxes will be owed on non-medical expenses.
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HSA vs IRA
When it comes to HSA vs IRA, there are several key differences to consider. Both are tax-advantaged accounts, but the specifics vary. Here is a detailed comparison:
Tax Advantages
The primary difference between HSAs and IRAs lies in their tax benefits. A Health Savings Account (HSA) offers a triple tax advantage:
- Contributions are either tax-free (if made by an employer) or tax-deductible (if made with post-tax dollars).
- The growth of the account through interest or investments is not subject to taxes.
- Distributions spent on qualified health expenses are tax-free at any time.
On the other hand, IRAs, including both Traditional and Roth options, offer a single tax advantage. With a Traditional IRA, contributions are made pre-tax, while with a Roth IRA, distributions are tax-free in retirement.
Withdrawals
The rules regarding withdrawals differ between HSAs and IRAs. With an HSA, you can withdraw funds tax-free at any time to pay for qualified medical expenses. There is no minimum age requirement for penalty-free withdrawals. However, if you use HSA funds for non-medical purchases before the age of 65, you will be charged a 20% penalty in addition to income taxes. After turning 65, you can use HSA funds for any purpose without penalty, although non-medical withdrawals will be taxed as regular income.
In contrast, IRAs have stricter rules for withdrawals. With a Traditional IRA, you must reach the age of 59 1/2 to avoid a 10% penalty tax on withdrawals. Additionally, once you turn 72, you are required to start taking minimum distributions, which are taxed as regular income. With a Roth IRA, you can withdraw your contributions at any time without taxes or penalties, but to take out earnings tax-free, you must meet the age requirement of 59 1/2.
Contribution Limits
HSA and IRA contribution limits also differ. For 2024, the HSA contribution limit for individuals with a health plan is $4,150, increasing to $5,150 if you're 55 or older and eligible for the annual $1,000 catch-up contribution. For families, the HSA limit is $8,300, or $9,300 if you're 55 or older.
IRAs have higher contribution limits. For 2021, the limit for a Traditional or Roth IRA was $6,000, rising to $7,000 if you were 50 or older. However, Roth IRAs have income-based contribution limits, so higher-income individuals may not be able to contribute the full amount.
Investment Options
Both HSAs and IRAs can be used for investing, although the investment options may vary depending on the provider. HSAs often offer a range of investment choices, including stocks, bonds, mutual funds, and ETFs. IRAs also provide various investment options, and you can typically choose from a wide array of investments to build a diversified portfolio.
Eligibility
Eligibility requirements differ between HSAs and IRAs. To contribute to an HSA, you must be enrolled in a qualified high-deductible health plan (HDHP). There are no such requirements for IRAs, and anyone can open a Traditional or Roth IRA, although contribution limits may apply based on income.
In summary, both HSAs and IRAs offer valuable benefits for saving and investing. The right choice depends on your individual circumstances, including your health insurance coverage, tax situation, and financial goals. It's important to understand the features and restrictions of each type of account before deciding which one aligns best with your needs.
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HSA investment options
A health savings account (HSA) is a great way to save for future healthcare expenses or your retirement. It offers a triple tax benefit, meaning contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are not taxed.
There are a few different HSA investment options to choose from, depending on your preferences and financial goals. Here are some of the most common options:
Choice:
This option is ideal for experienced investors who may not need guidance from a professional. It offers a simplified brokerage experience with a large range of stocks, mutual funds, exchange-traded funds (ETFs), and more. You can download the list of available investments, which may change as they are continuously monitored by the SEC-registered investment advisor.
Select:
This option provides a recommended list of mutual funds, specific to your unique risk tolerance and investment objectives. An SEC-registered investment advisor (RIA) selects all funds, and they are organized by asset class and aligned with your investment profile. You will complete a short HSA risk-tolerance questionnaire to determine your investment mix, and you have the opportunity to make the final decision about your investments and allocations.
Managed:
This option offers an even higher level of personalization, where an RIA actively manages and rebalances your investments on your behalf. You will complete a short HSA risk-tolerance questionnaire that provides insight to the RIA on your investment objectives, time horizon, and comfort level with investment risk.
Other Investment Options:
- Money market funds: These are low-risk, low-return options, making them suitable if you keep a small balance in your HSA or plan to use the funds regularly.
- Stocks: Stocks are a good option if you don't expect many medical expenses in the coming years. They can provide high returns but come with volatility, so it's important to have a portion of your account in cash or money market funds to cover short-term costs.
- Index funds: These funds allow investors to purchase a diversified group of stocks that track indexes like the S&P 500 or Russell 2000. They have low fees, and you can find them as both mutual funds and ETFs.
- Dividend funds: These funds hold dividend-paying stocks, which are typically from profitable and established companies. Dividends won't be taxed and can be reinvested or held as cash in your account.
- Individual stocks: This is the riskiest approach, as it involves holding a small number of individual stocks. While it can provide high returns, there is also a higher risk of loss if your investments are not diversified.
Remember, investing HSA funds is a great way to maximize the benefits of your account. The longer you invest, the greater your potential growth. However, it's important to consider your unique circumstances, risk tolerance, and future medical needs when determining your investment strategy.
HSA eligibility
To be eligible for an HSA, you must meet the following requirements:
- Be covered by a high-deductible health plan (HDHP) on the first day of the month.
- Not be covered by other health insurance (see Publication 969 for exceptions).
- Not be enrolled in Medicare (the individual can be HSA-eligible for the months before being covered by Medicare).
- Not be eligible to be claimed as a dependent on someone else's tax return.
If you are married, each spouse who is an eligible individual and wants to have an HSA must open a separate HSA. Married couples cannot have a joint HSA, even if they are covered by the same HDHP.
HSA vs FSA
A Health Savings Account (HSA) and a Flexible Spending Account (FSA) are both accounts that allow you to set aside money before it's been taxed to pay for healthcare-related expenses. However, there are some key differences between the two.
Firstly, to qualify for an HSA, you must be enrolled in a high-deductible health plan, whereas anyone can contribute to an FSA as long as their employer offers it. HSAs may also offer higher contribution limits, and you can carry unused funds forward indefinitely, whereas FSAs generally have lower contribution limits and are often subject to a "use it or lose it" rule, meaning you may forfeit unused funds at the end of the benefit year.
Another difference is that you can invest the money in your HSA to benefit from compound interest, whereas you cannot do this with an FSA. HSAs also offer a triple tax benefit: contributions are tax-deductible, investment earnings are tax-free, and withdrawals for qualified medical expenses are not taxed. While withdrawals from an FSA for qualified medical expenses are also not taxed, if you withdraw funds from an HSA for non-qualified expenses, you will be charged a 20% bonus penalty in addition to income taxes on the withdrawal.
Finally, an HSA belongs to you, even if you opened it through your company, whereas an FSA is owned by your company.
Frequently asked questions
A health savings account (HSA) is available if you have a high-deductible health insurance plan, and it helps pay for out-of-pocket medical expenses.
HSAs come with a triple tax benefit: contributions are tax-deductible, earnings remain tax-free as long as they're used for qualified medical expenses, and money can be withdrawn tax-free at any time to pay for these expenses.
This depends on your unique circumstances, including your risk tolerance and potential future medical needs. If you're using an HSA mainly as a retirement account, then it could make sense to opt for high-return investments. Some options include index funds, dividend funds, and individual stocks.
Once you reach age 65, money in your HSA can be withdrawn and used for any reason. If it's used for non-qualified expenses, you'll be taxed on the withdrawal. You can continue contributing to an HSA as long as you're covered by an HSA-compatible health plan and aren't enrolled in Medicare.
There may be fees associated with investing in an HSA, such as annual asset-based fees or internal expenses for mutual funds. Be sure to check with your specific HSA provider to understand any applicable fees.
