Why Health Savings Accounts Are One of My Favorite Investment Tools

Amongst the abundance of decisions we make in our finances, what types of investment accounts we use is a common one I am tasked with helping clients think through. While IRAs and 401(k)s are popular choices due to their tax-free growth potential, there's another option that often flies under the radar but offers incredible benefits: the Health Savings Account (HSA).

Most people think of HSAs primarily as a tool to pay for health expenses—which they are, but with some additional planning, they can be wildly beneficial for future you.

The biggest kicker for the HSA is the triple tax advantage it offers:

1. Tax Deduction for Contributions: Contributions to an HSA are tax-deductible, reducing your taxable income for the year you make the contribution.

2. Tax-Free Growth: Just like IRAs and 401(k)s, the funds in an HSA can be invested and grow tax-free over time.

3. Tax-Free Withdrawals for Qualified Medical Expenses: When you use HSA funds for qualified medical expenses, the withdrawals are tax-free.

This means there's a possibility of never having to pay taxes on the money you contribute to and invest in an HSA—a benefit that doesn’t exist in any other investment vehicle!

If all you wanted to do was use your HSA as a funnel for healthcare spending, where you contribute to it and then pay for medical expenses every year, it would still be a great tool, but there is a fun way to take even better advantage of the tax-free growth.

Not using your HSA for health expenses (yet).

The strategy is to fund your HSA to the maximum allowed limit (or as much as you can) and pay for any healthcare expenses out-of-pocket. This approach allows the funds in your HSA to remain invested and grow over the long term. As we all know, healthcare expenses are inevitable, especially as we age. By allowing your HSA to grow, you’re essentially preparing a robust financial cushion for your future self, who will likely have higher medical costs.

There is also additional flexibility that shows up after you turn 65. You can then withdraw funds for any reason, not just medical expenses, and only pay income tax on the distributions (no penalty)—similar to a traditional IRA or 401(k). Even if you’re fortunate enough to have minimal health expenses, your HSA funds won’t go to waste.

At the risk of making this article way too long to read, I can’t let you go without telling you about reimbursing past expenses. If you follow the strategy above by funding an HSA and paying for medical expenses out of pocket, you can reimburse yourself for those past medical expenses, provided you were covered by an HSA when the expense occurred and kept the receipt. This means that if, ten years down the line, you need cash, you can reimburse yourself for an expense you had today. This flexibility offers a unique financial planning opportunity and adds another layer of value to the HSA.

If you have medical expenses and DON’T have the cash flow to cover those, then by all means, use your HSA dollars, that is what they are for. But for those of you who can manage, or have smaller health costs, letting that HSA money grow over time is one of the most tax-advantaged investment strategies you can implement!