If your health insurance plan qualifies you for a Health Savings Account (HSA), you should have one. In fact, in certain instances, it might make sense to switch to an HSA eligible health insurance plan in order to utilize the benefits of the HSA.

When most people use an HSA, they contribute to the HSA & use that money to pay for their medical expenses. While that is certainly advantageous, I want you to consider using the HSA a bit differently if your situation will allow.

Note: This is intended as general educational information only. Your situation may be different. You should consult with your financial adviser and tax professional before taking any action.

Click here if you would like a better understanding of HSA’s.

Originally created in 1996 as Medical Savings Accounts and evolved in 2003 to Health Savings Accounts, HSA’s have grown in popularity year over year as a tool to assist Americans in paying for rising health care costs.

HSA’s are one of the only triple-tax advantaged vehicles out there. They offer pre-tax/tax-deductible contributions, tax-free growth, and tax free withdrawals if the money is used for qualified medical expenses.

These are enormous tax benefits and it is important to figure out how we can maximize the savings.

How HSA’s are Normally Used

According a study by Morningstar’s HelloWallet, approximately 96% of people spend the money within the HSA each year or save their annual contributions in a savings account similar to a money market account. The other 4% of participants invest at least a portion of their balances.

It’s the investment option within an HSA that we will be examining in this article.

Should I Spend or Save HSA Money?

Given the enormous tax benefits of an HSA, it might make sense to use other savings to pay for medical expenses and leave the HSA funds to be invested for retirement. To illustrate my point, let’s look at the numbers a little more closely.

Here is a simplified example. Again, I stress simplified. In this example, we are going to say that you have $15,750 each year before taxes are taken out to save and spend on medical expenses. Why this amount? We simply need to make sure we’re comparing apples to apples. We are going to estimate that your medical expenses are $6,750 each year (post-tax). We will estimate your marginal federal tax rate at 25% and your capital gains tax rate at 15%. You have 30 years until retirement, and you’re expecting a 5% return on investment.

Here are the following scenarios that we’re going to examine:


  1. You spend the money each year for medical expenses out of the HSA and you save the rest in a taxable account for 30 years.
  2. You have an HSA. You use your taxable savings to pay for medical expenses and you invest the money inside your HSA for 30 years.


Scenario 1: Spend the HSA Money

$6,750HSA Contribution (Used for Medical Expenses)
=$9,000Taxable Income
*(1-0.25%)1-(Tax Rate) = Post Tax
=$6,750Invested each year for 30 Years


In this scenario the HSA Contribution is used for the medical expenses and the $6,750 is saved each year in a taxable account. After 30 years, if you we’re to invest that money with a 5% average return in a vehicle which paid no annual dividends, you would have $411,567.89 after a 15% capital gains tax on the growth.


Scenario 2: Save the HSA Money

$6,750HSA Contribution (Invested for 30 Years)
=$9,000Taxable Income
*(1-0.25%)1-(Tax Rate) = Post Tax
=$6,750Used for Medical Expenses


In this scenario, you contribute $6,750 per year to the HSA, invest that money, and you spend $6,750 each year out of the HSA to pay for your medical expenses. After 30 Years, with an average 5% return, you would have $448,462.22. If the money is withdrawn for medical expenses during retirement, you will not have to pay any taxes on the money.

Here we see an extra tax savings of $36,894 at retirement simply by using the HSA as a retirement vehicle. It is likely that the savings would be even more because most investments pay annual dividends. It also should be considered whether or not the government will maintain the additional 3.4% Net Investment Income Tax on individuals making $200,000 or more ($250,000 for couples). For many of our clients, we are expecting a savings of $50,000 to $70,000 by using the HSA as an additional retirement vehicle.

Costs Matter

The investment selection and fees within your HSA is an important factor in this. The less efficient it is, the less the savings will be. It may even result in a net loss. That is why investment selection and fees must be taken into account. Fortunately, there are a lot of good options out there if your employer’s HSA is less efficient and you can maintain the more than one at a time.

What if the Funds Aren’t Used for Medical Expenses?

Not using the money for medical expenses certainly should be an important consideration. If you’re under 65 and you use the HSA funds for something other than medical expenses, you’ll incur taxes and a 20% penalty. If you’re over 65, and the funds are used for non-qualified expenses, you simply pay income tax on the withdrawals (similar to an IRA). However, with careful planning, that’s generally easy enough to avoid.

Also keep in mind that for a couple retiring today, medical expenses throughout retirement are estimated to be about $260,000[1]. That’s not including any potential long-term care needs. If you’re retiring in 30 years, that number will be $545,000 (assuming 2.5% inflation).  Medical expenses in retirement will be a major area of concern. You will certainly benefit from saving for those expenses in a tax-free vehicle.

In conclusion, I believe it to be wise, in most instances, to bump up HSA investments in your savings priority order. Of course, it shouldn’t go before emergency savings or a 401(k) with a match; however, it may be next in line. As always, tax diversification is an important key to long-term financial success, which means you shouldn’t necessarily focus on one and not the other.

[1] According to a study from Fidelity Benefits Consulting

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