Maximizing Your Hsa: Choosing The Right Investment Funds

Health savings accounts (HSAs) are a great way to save for future medical expenses or boost your retirement funds. HSAs come with a triple tax benefit: contributions are tax-deductible, earnings on the account remain tax-free, and withdrawals for qualified medical expenses aren't taxed either. While investing HSA funds is one of the best ways to take advantage of the account, only about 13% of HSAs were invested in 2022. If you're considering investing your HSA funds, here are some things you should know.

HSA funds can be used to supplement retirement savings

A health savings account (HSA) is a great way to save for future medical expenses, but it can also be used to supplement your retirement savings. HSAs offer a triple tax benefit, which makes them attractive savings options. Contributions to HSAs are tax-deductible, with individuals able to contribute a certain amount each year, and families able to put in double that amount. Those aged 55 and older can contribute an additional catch-up contribution. Any earnings on the account remain tax-free as long as the money is used for qualified medical expenses such as deductibles and co-payments. The money can be withdrawn tax-free at any time to pay for these qualified medical expenses, and it rolls over from year to year.

If you spend your HSA money on non-qualified expenses, you'll be charged a 20% bonus penalty in addition to income taxes on the withdrawal, until you reach the age of 65, when the bonus penalty disappears. This means that HSA funds can be withdrawn and used for any reason, but you will be required to pay ordinary income tax on the withdrawal. Because of this, some people treat their HSA as another retirement account, similar to an IRA or 401(k).

If you're investing your HSA funds, it's important to consider your unique circumstances, including your risk tolerance and potential future medical needs. For example, if you're using an HSA mainly as a retirement account, then it could make sense to opt for high-return investments. Here are some options:

• Money market funds: If you keep a relatively small balance in your HSA or you plan to regularly tap the account, it could make sense to go with low-risk, low-return options such as these.
• Stocks: If you don't expect much in the way of medical expenses in the coming years, stocks are likely to be one of the best ways to invest and grow your HSA. Keep in mind that stocks are volatile, so if you're relying on your HSA to cover out-of-pocket medical costs over the next year or two, it's best to keep a portion of your account in cash or money market funds to ensure the money is there when you need it.
• Index funds: These allow investors to purchase a broadly diversified group of stocks that track indexes such as the S&P 500 or Russell 2000. They come with rock-bottom fees, which means more of your returns will benefit you instead of the fund's manager.
• Dividend funds: Funds that hold dividend-paying stocks can also be a good fit for HSA investing. Companies that pay dividends are typically profitable and established, which might make them safer than younger companies without a proven business model. Plus, you won't be taxed on the dividends, which will be available to either be reinvested or held as cash in your account.
• Individual stocks: The riskiest approach to take with investing your HSA is to hold a small number of individual stocks. While they can provide outsized returns, the risk is magnified if you're wrong because you won't have a diversified portfolio to protect you. Make sure you understand the business model, competitive position and valuation of any company you invest in.

If you have a lower risk tolerance or think you might need money for future medical expenses, it's best to focus on investments with less risk. Short-term bond funds will likely make the most sense for those in that scenario. The funds can generate some cash and will be relatively stable, meaning you'll be less affected by fluctuating interest rates.

It's important to note that not everyone can open an HSA. To be eligible, you must be on a high-deductible health plan. These plans require you to spend relatively high amounts from your own pocket on deductibles before your health insurance will provide any reimbursement. High-deductible health plans aren't ideally suited for those with high medical expenses.

HSA funds offer a triple tax advantage

A health savings account (HSA) is a great way to save for future medical expenses and comes with a triple tax advantage. Firstly, contributions to an HSA are tax-deductible, meaning you can reduce your taxable income by making deposits into the account. Secondly, any earnings on the account, such as investment returns, are not taxed as long as the money is used for qualified medical expenses. Finally, you can withdraw money from your HSA tax-free at any time to pay for qualified medical costs. This triple tax benefit makes HSAs very attractive for saving for future health costs and even for boosting your retirement funds.

The triple tax advantage of HSAs is a significant benefit, but it's important to remember that there are also potential drawbacks. For example, HSAs must be tied to a high-deductible health plan, which may not be suitable for individuals with high medical expenses. Additionally, some HSA providers may require a minimum balance before you can start investing your funds, and they may charge fees for their services.

Despite these potential drawbacks, HSAs can be an excellent way to save for future health costs and supplement your retirement savings, especially if you take advantage of the triple tax advantage they offer.

HSA funds can be used to pay for medical expenses

A health savings account (HSA) is a great way to save for future medical expenses and offers triple tax benefits. Contributions reduce your taxable income, the money grows tax-free, and withdrawals for qualified medical expenses aren't taxed either.

You can invest HSA funds in the same way you would an individual retirement account (IRA) or other investment accounts. It's important to note that some HSA providers require a minimum balance before you can invest your money, so be sure to check with your provider.

• Risk tolerance and future medical needs: If you have a high risk tolerance and don't anticipate significant medical expenses in the near future, consider investing in stocks or mutual funds, which offer higher returns but come with greater risk. If you have a lower risk tolerance or expect upcoming medical costs, consider lower-risk options like money market funds or short-term bond funds.
• Diversification: Diversify your investments across different types of assets, such as stocks, bonds, mutual funds, or exchange-traded funds (ETFs). This helps to reduce risk and improve long-term returns.
• Time horizon: If you have decades until retirement, consider investing in more aggressive options like stocks or mutual funds. If retirement is just a few years away, opt for less volatile choices like bonds or dividend-paying stocks.
• Employer matching contributions: Take advantage of any employer matching contributions to maximize the funds available for qualified medical expenses and potentially free up more money for investing.
• Contribution limits: Contribute the maximum amount allowed to your HSA to make the most of this tax-advantaged account. For 2024, the maximum contribution limits are $4,150 for individuals and $8,300 for families.
• Retirement strategy: Consider your HSA as a key component of your overall retirement strategy. Try to invest as much of your HSA funds as possible while ensuring you keep enough cash to cover qualified medical expenses.
• Avoid frequent withdrawals: Leave as much money as possible in your HSA to maximize its growth over time. Avoid taking out funds unless necessary, as this can impact the long-term performance of your investments.

Remember, investing your HSA funds is a personal decision that depends on your financial situation, risk tolerance, and future medical needs. Be sure to carefully consider your options before making any investment decisions.

HSA funds can be withdrawn tax-free for qualified medical expenses

A Health Savings Account (HSA) is a tax-exempt trust or custodial account that allows you to set aside money on a pre-tax basis to pay for qualified medical expenses. HSA funds can be withdrawn tax-free for qualified medical expenses, which include deductibles, copayments, and other expenses. Here are some key points to consider:

• Tax Benefits: Contributions to an HSA reduce your taxable income, and the money grows tax-free. Withdrawals for qualified medical expenses are also tax-free.
• Rollover: Unspent HSA funds roll over from year to year, allowing you to accumulate tax-free savings for future medical expenses.
• Investment Options: You can invest HSA funds in various options such as stocks, bonds, mutual funds, and ETFs. This allows your HSA funds to grow faster than saving alone.
• Qualified Medical Expenses: Qualified medical expenses include deductibles, copayments, and other healthcare-related costs. It's important to keep receipts for qualified medical expenses to substantiate HSA withdrawals.
• Retirement Planning: HSA funds can also be used for retirement planning. Once you turn 65, you can use HSA funds for any purpose without penalty. However, non-medical withdrawals before age 65 may be subject to taxes and penalties.
• Employer Considerations: If your HSA is offered through an employer, there may be limitations on how you can invest the funds. Additionally, if your employer contributes to your HSA, those contributions are typically excluded from your gross income.

HSA funds have investment options, including stocks, bonds, mutual funds, and ETFs

Health savings accounts (HSAs) are a great way to save for future medical expenses and can also be used to boost your retirement funds. HSAs offer a triple tax benefit: contributions are tax-deductible, earnings on the account remain tax-free as long as the money is used for qualified medical expenses, and withdrawals for qualified medical expenses aren't taxed either.

While HSAs are a great way to save for future health-related expenses, you can also invest your HSA dollars to make your money grow faster. Some HSAs offer tools to help you choose your investments and provide automatic rebalancing, while others allow you to select from specific investments, such as stocks, bonds, mutual funds, and ETFs.

• Stocks: Investing in stocks can be a great way to boost the growth of your HSA, but it's important to keep in mind that stocks are volatile. If you're planning to use your HSA to cover out-of-pocket medical costs in the near future, it's best to keep a portion of your account in cash or money market funds to ensure the money is there when you need it.
• Mutual funds and ETFs: Mutual funds and ETFs offer diversification across a basket of stocks, automatic dividend reinvestment, and relatively low fees. Index funds, in particular, have rock-bottom fees, allowing you to keep more of your returns.
• Bonds: If you have a lower risk tolerance or expect to need money for future medical expenses, short-term bond funds might be a better option for you. These funds can generate some cash and are relatively stable, meaning you'll be less affected by fluctuating interest rates.

When deciding how to invest your HSA, it's important to consider your unique circumstances, including your risk tolerance and potential future medical needs. If you're using your HSA primarily as a retirement account, you might opt for high-return investments. On the other hand, if you plan to tap into your HSA regularly, low-risk, low-return options like money market funds might be a better choice.

Frequently asked questions