A health savings account, or HSA, is a specialized type of account designed to help people with certain healthcare plans save money for their out-of-pocket healthcare costs. But there’s so much more to the HSA than its primary goal as a tax-advantaged way to pay for medical care. In fact, the HSA could be one of the best retirement planning tools available to you, hiding in plain sight.
With that in mind, here’s a rundown of how HSAs work, how to take advantage of your HSA (or open a better one), and what using an HSA could mean to your financial health in retirement.
Health savings account vs. flexible spending account
HSAs are often confused with flexible spending accounts, or FSAs. It’s easy to see why, as both accounts are designed to let you set aside money for healthcare expenses in a tax-advantaged manner. However, there are two key differences to be aware of:
First, FSAs are generally “use it or lose it” accounts. In other words, money you contribute to an FSA typically must be used for healthcare expenses before the end of the year (with a few exceptions). Meanwhile, HSA money can carry over from year-to-year.
Second, while FSAs are essentially a tax-advantaged place to park cash until it’s used for qualifying expenses, money in HSAs can be invested. We’ll discuss this in detail later, but you often have several investment options to choose from, similar to a 401(k).
In some cases, you can contribute to an FSA and HSA in the same year, and this can actually be a good strategy for many people. If you have an HSA-compatible FSA (check with your benefit administrator), the FSA can be useful to save for certain current-year healthcare expenses, while the HSA can used for more long-term purposes, as we’ll discuss in a bit.
A rare triple tax advantage
We think there’s a solid argument to be made that maxing out an HSA should be the biggest priority when it comes to tax-advantaged places to allocate your income. And the biggest reason is that an HSA has a rare triple tax benefit that other tax-advantaged accounts (including retirement accounts) don’t offer.
Specifically, money contributed to an HSA can be excluded from taxable income in the year contributions are made. This means that if you earn $100,000 and contribute $3,000 to an HSA, your taxable income will be reduced to $97,000 before any other deductions or adjustments are applied.
While your money is in your HSA, it is free to grow and compound on a tax-deferred basis. So, you won’t receive tax documents for any dividends or capital gains in your HSA every year.
Finally, as long as you use the money to pay for qualifying healthcare expenses (and there’s a large list of what qualifies), your withdrawals from an HSA will be completely tax-free. And this is true regardless of how much your investments have grown.
In a nutshell, picture an investment account that combines the tax deduction of a traditional IRA with the tax-free income potential of a Roth IRA. That’s the tax structure of an HSA.
Do you qualify for an HSA?
The main requirement to be eligible for an HSA is being enrolled in an eligible health plan. HSAs are designed to make it easier for people enrolled in health plans with high deductibles to budget and save for medical expenses.
For 2023, in order for a healthcare plan to be HSA eligible, it has to meet two criteria. First, the plan’s deductible must be at least $1,500 for self-only coverage, or $3,000 for family coverage. Second, the out-of-pocket maximum must be no greater than $7,500 for single coverage, or $15,000 for family health coverage.1
In addition to being enrolled in a qualifying health plan, you also must meet a few other criteria:
- You can’t be enrolled in an ineligible health plan. In other words, if you’re enrolled in an HSA-eligible plan, but are also covered by another health plan that doesn’t meet the requirements, you cannot contribute to an HSA.
- Similarly, you cannot be enrolled in Medicare and contribute to an HSA, regardless of your other health coverage.
- You cannot be claimed as dependent on someone else’s tax return.
How much can you put in an HSA?
Similar to most tax-advantaged accounts, health savings accounts have annual contribution limits. They change every year to keep up with inflation, and there are separate limits if you have health coverage just for you or coverage for your entire family.
The 2023 HSA contribution limit is $3,850 for single health coverage or $7,750 for family coverage.2 For 2024, the HSA contribution limit is increasing to $4,150 for single health coverage and $8,300 for family coverage. These limits include any employer contributions, as more than three-fourths of employers that offer HSAs contribute on behalf of participants.
In addition, there is a $1,000 catch-up contribution allowed for people 55 and older, regardless of whether they have single or family coverage. And just like IRAs, the contribution deadline for HSAs is same as the tax deadline for the contribution year. In other words, 2023 HSA contributions can be made until April 15, 2024.
In order to make a contribution for a given tax year, you must be enrolled in an HSA-eligible plan as of Dec. 1.
How an HSA can boost your retirement readiness
Now let’s get into why we’re suggesting an HSA as a retirement tool.
For one thing, even with Medicare, healthcare can be expensive in retirement. A report by Fidelity found that the average 65-year-old who retires in 2023 will spend $157,500 on healthcare throughout their retirement – that’s $315,000 for a retired couple.3 Contributing to an HSA every year and letting it grow can be a great way to not only produce tax deductions every year, but to create a tax-free source of funds to cover these expenses.
In addition, there’s an HSA rule that says you can use the money in your account for any purpose after you turn 65. Non-healthcare withdrawals will be treated as taxable income, but the point is that if you end up with more money in your HSA than you need to pay your healthcare expenses, you can treat your HSA as another retirement account once you hit 65.
What kinds of investments can you make through your HSA?
The short answer is: It depends. While about two-thirds of employer-sponsored HSAs offer investment options, that means one-third of them don’t. Of those that do, the investment options often look similar to what you might expect from a 401(k) – that is, a “menu” of investment funds to choose from.
However, you can also open an HSA through a brokerage, and this can dramatically increase your options. For example, Fidelity offers both managed HSAs that invest in an appropriate portfolio of mutual funds as well as self-directed HSAs that allow account owners to put their HSA funds into stocks, bonds, ETFs, mutual funds, and other investment options available on Fidelity’s platform.4 You can even transfer money from another HSA into a Fidelity account if you are dissatisfied with the options available to you.
It's also worth noting that you can have more than one active HSA. For example, if your employer contributes money into an HSA for you each year, you can use that and another HSA you open that has more investment flexibility — as long as the total contributions don’t exceed the limit.
How much can your HSA be worth by retirement?
There’s no way to accurately predict years of investment returns. All investing involves risk and may lose money (including principal). Plus, while you may be comfortable investing your HSA funds in ETFs or individual stocks, another investor might feel more comfortable investing in fixed-income instruments.
Having said that, here’s a simplified example. Let’s say that you’re 45, married, you set aside $7,000 in an HSA in 2023, and do the same every year thereafter until you turn 65. Depending on your tax bracket, this will likely result in over $1,000 in tax savings every year. And, if you averaged 7% annual investment returns within the account, you’d have about $314,000 by the time you retire. This would completely cover the average retired couple’s lifetime healthcare needs, and that assumes the account doesn’t earn another dime after you turn 65, which is highly improbable.
Most people don’t take advantage of their HSA’s compounding power
While HSAs can be great financial tools, most people don’t even come close to taking advantage of their HSA’s benefits. For one thing, the average HSA balance at the end of 2021 was just $3,902, according to the Employee Benefit Research Institute.5 Only 13% had balances over $10,000.
Here's the most most shocking statistic: only 7% of active HSA accounts have money invested in mutual funds or other investments, according to Devenir Research.6 In a nutshell, most people with HSAs use them as spending accounts, ignoring the saving and investing use cases. The same report by Devenir showed that HSA participants contributed $47 billion to their HSAs in 2022 and withdrew nearly three-fourths of it to pay for healthcare.
To be fair, a big reason for this is that the public doesn’t know how HSAs really work. The account type itself was established in 2003, but most employers focus their education programs on the immediate tax benefits of HSAs, not their investing and retirement potential. But, by understanding how HSAs work, you’ll be equipped to take full advantage of this incredibly powerful financial tool.
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