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Infographic: Health Savings Account (HSA) 101
Health Savings Account (HSA) Explained for Beginners
With an HSA, you’ll never pay taxes if you use it right. But over 80% of people are missing out on its best feature.
I passed the CFP® exam at 16 and have helped millions improve their finances over the last 8 years.
I’ll explain exactly how an HSA works and how to turn it into a powerful wealth-building tool, plus a bonus feature that nobody talks about.
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How Does an HSA Work
An HSA, or Health Savings Account, is a tax-advantaged account where you can save for medical expenses.
Here’s what that tax advantage means:
- Contributions reduce your federal income tax when you contribute
- The money then grows tax free in the account, and
- Withdrawals for qualified medical expenses are also tax-free
To contribute, you generally need to be enrolled in a high-deductible health insurance plan that’s HSA-eligible. You can’t be enrolled in Medicare, and you also can’t be someone else’s tax dependent.
You can open an HSA through your employer or independently.
And here’s a bonus tax benefit:
If your employer offers an HSA through a cafeteria plan, you’ll also avoid Social Security and Medicare payroll taxes on contributions, which saves you 7.65%.
However, 3rd party HSAs and employer HSAs outside a cafeteria plan don’t have this benefit.
But the biggest benefit appears when you leave money in your Health Savings Account for years.
The HSA Superpower: Investing Within a Health Savings Account
Over 80% of people contribute to an HSA and use it to pay for current medical expenses – but this means they have to keep the money as cash.
Instead, by investing that money for the long term, you can build up a significant pool that can be used later for medical expenses.
Say you invest $4,000 in the stock market through your HSA every year, from age 25 till you retire at 60. You’d end up with over $1.3 million!
If your employer’s HSA doesn’t offer investments, that’s okay. You can still contribute to save on payroll taxes, and then transfer the money to an independent HSA regularly to invest the money.
This is especially powerful because of the generous withdrawal rules.
Health Savings Account HSA Withdrawal Rules
While studying for the CFP® exam, I learned that an HSA can reimburse qualified expenses years or even decades after you paid them.
So you could let the money grow for 40 years and then withdraw tax-free based on medical bills that you paid in your 20s.
The expense just needs to be from after the Health Savings Account was opened, and you need records to show that it wasn’t reimbursed in some other way or claimed as a tax deduction.
So if you can afford it, it’s a good idea to pay medical bills with other cash, save your receipts, and make regular contributions to your HSA that you invest in the stock market.
Before age 65, withdrawals that aren’t for medical expenses are generally taxable and can face an additional 20% penalty.
But after age 65, that penalty disappears. So for non-medical withdrawals, you only pay regular federal income tax – just like an IRA or 401k.
Withdrawals for medical expenses continue to be tax free, including for most Medicare premiums.
But even people who invest the money in their HSA can easily fall for a few common mistakes.
Check this out to avoid 4 beginner investing mistakes that cost investors tens of thousands over the long run, so you can make the most of your investments: 4 Beginner Investing Mistakes That Are Quietly Costing You Thousands