As a kid, I loved pinball, especially the thrill of hitting a hidden ramp that sent my score soaring. Investing can feel the same way, with the right strategy employed, you can multiply your wealth. Enter the Health Savings Account (HSA), a powerhouse with a triple tax benefit no other account offers. Yet, shockingly, most people miss this opportunity or implement it incorrectly. This article is for those with the cash flow to cover medical bills today and looking to benefit from the HSA’s tax advantages and build a tax-free nest egg.

When I started my first job, I chose a High Deductible Health Plan (HDHP) with an HSA to save on premiums. Given that I was young and healthy it made perfect sense to pay a lower premium and bank the unspent money for any future medical expenses. Unfortunately, that was as far as it went. No one ever talked to me about how I could build a six-figure balance that would never be taxed again. Apparently, I wasn’t the only person missing this golden opportunity.

According to the Employee Benefit Research Institute, only 13% of HSA account holders invested their assets in 2022. This trend has continued to persist which means the most effective account for investing is being dramatically underutilized by participants. The main reasons likely include:

Reason 1: The HSA holder lacks sufficient outside funds to cover medical expenses. They are forced to immediately withdraw their funds after contributing and pay medical bills. If they were to invest, it would need to be in a very low risk investment that meets short term liquidity demands like cash.

Reason 2: The HSA holder has ample cash flow to pay medical bills but is not aware of the process to max fund their HSA. This is the crowd that I’m writing this article for, and I will detail how best to implement this strategy.

The Basics:

Contributions are tax-deductible, reducing your taxable income.
Earnings grow tax-free, compounding without tax drag.
Withdrawals at any age for medical expenses are tax-free. After age 65, withdrawals for medical expenses are tax-free while withdrawals for any other reason are taxed as ordinary income.

How High Income Earners Can Leverage their HSA to Create Wealth

Step 1:

Determine if a HDHP is right for you and your family and enroll. A HDHP tends to be a better fit for individuals and families that use the healthcare system less and anticipate lower bills. If you anticipate frequent doctor visits, have chronic conditions or need expensive prescriptions, a Low Deductible Health Plan may be best. Minimum annual deductible amounts for qualifying HDHP plans are provided below.

There are also eligibility requirements which include not being enrolled in Medicare or being claimed as a dependent by someone else.

*Deductible minimum is how much expense is paid out-of-pocket before insurance kicks in.

Step 2:

Fund your HSA up to the maximum. These amounts are shown below. Some employers will match contributions to your HSA making them even more appealing.

*Age 55+ can contribute an additional $1,000

Step 3:

Resist the urge to tap into your HSA for today’s bills – think of it like a retirement account, not a checking account. This is the step that most people miss. Using your HSA funds for qualified medical expenses today will prevent you from enjoying the tax-free growth component of the triple tax benefit. Instead, use cash flow outside of your HSA to pay for the qualified expenses. Doing this will help you accumulate a large balance faster.

Step 4:

Keep your receipts! This step is critical to the process if you want future tax-free withdrawals. Now, if there are no receipts to match with future withdrawals don’t get too worried. Withdrawals after age 65 are treated like an IRA and only pay income tax if not used for qualified medical expenses. However, withdrawals before age 65 without a qualified receipt are subject to ordinary income taxes and a 20% penalty.

Thankfully, there are apps like HSA Store’s tracker that simplify storing receipts digitally, ensuring your penalty proof. A link to the app is provided here, although we don’t endorse any providers. You can also visit IRS publication 969 for detailed guidelines on recordkeeping.

Step 5:

Invest your HSA. There are many platforms that allow for investing and I won’t cover them all in this article. However, it is important to ensure your provider allows for investing. Optum, HSA Bank and Fidelity are a few providing this service. Then choose investment options that align with your risk tolerance and investment time horizon, like how you would go about investing your retirement account.

Withdraw your HSA balance as needed after turning 65. This is the time in life when medical expenses are the highest and having a high HSA balance will prove useful. Medicare premiums can also be covered with your HSA funds. Recall, if your funds exceed your medical expenses, that is fine. Withdrawals will be taxed as ordinary income just like an IRA.

The Math Behind the Numbers

Now that I have laid out the steps to maximizing your HSA, let’s look at the math with an example.

Let’s assume Joe, who is 40 years old begins by contributing the maximum amount for him and his family. The maximum begins at $8,550 and adjusts upward by the rate of inflation every year. He contributes the maximum for 25 years and never spends from his HSA. Instead, he covers any medical bills with his income and keeps his receipts. His past medical receipts and future medical expenses total $350,000. Recall, any dollar offset by a qualified medical expense is treated as tax-free. After 25 years, inflation averaged 2% and his investments returned 6% annually. The results are summarized below.

The Results:

Who wouldn’t be happy accumulating $566,708 over 25 years, taking tax breaks along the way and paying no tax ever on $350,000 of that balance?! The numbers only get better with a higher rate of return or longer time horizon, but I think you get the point. This all sounds great, but you may be asking what the downside is. Let’s address some of the concerns.

What if I need the money before turning 65? Not a problem! HSA funds are intended to cover qualified medical expenses. If you need the money at any time before age 65, you can simply redeem the receipts that you have been saving. All money taken out of an HSA is 100% tax free up to the amount of any qualified expenses. This is a benefit not available to traditional retirement accounts.

Is a high-deductible health plan risky? Out-of-pocket expenses will be higher with a HDHP. However, you are still covered by the plan for major medical expenses so there is a limit to how much financial toll a major medical emergency can take. You could also suffer losses due to market fluctuations with your investments in the HSA. That’s why it is important to consult with a financial professional to ensure your investments aren’t taking on too much risk.

$350,000 in qualified medical expenses is high, is that reasonable? According to the Employee Benefit Research Institute (EBRI) to have a 90% chance of covering medical expenses in retirement it will take $351,000. You can read the report here. This amount does not include the qualified medical expenses incurred before the age of 65 that you will be saving the receipts for. So yes, it is reasonable to assume medical expenses will reach $350,000 and possibly more. Again, money used from your HSA to pay these expenses comes out tax-free!

That’s great, but what if I die before the funds are used? If the account owner passes before spending all the funds, they pass to the beneficiary much like an IRA would. For spouses, the account is treated as if it was theirs all along and is not taxable. Non-spouse beneficiaries must include the fair market value of the assets in their gross income. The rules are less favorable to non-spouse beneficiaries, but odds are the balance has been drawn down by the time it reaches them resulting in less balance to tax. Funds can also be used to pay the decedent’s final year of medical expenses.

Max funding an HSA is one more powerful tool for your wealth building toolkit. If you have started doing this already, that’s great! If not and you would like to learn more about how you can make it work for you please reach out to Ken or me. This article may also benefit a friend or family member.

Thank you for taking time to read this planning commentary. I pray it helps you or someone you care about.

Kyle Lottman, CFA, CMT, CPA
Wealth Management Advisor
Elevate Capital Advisors

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