There are a few of us at my day job that like to share information on financial independence. It was one of these conversations that opened my eyes to the potential of something I rarely thought about – my HSA.
An HSA, or Health Savings Account, is a tax-advantaged account for medical expenses that is available to those enrolled in a High Deductible Health Plan (HDHP). These are medical plans with cheaper premiums, but higher up-front out-of-pocket expenses that need to be met before the rest of the tab is picked up by the plan.
I always choose HDHP plans when my employer offers them, but this was the first employer that offered an HSA. Until this job, my employers instead offered Health Reimbursement Accounts (HRAs). HRAs are accounts only the employer pays into and you can’t take with you when you leave. Based on this experience I figured HSAs were probably the same thing with different letters. I was about to find out I was very wrong.
My employer contributes $500 to individual HSAs, and I had never contributed any of my own money on top of that. I looked at it as $500 in free healthcare for the year, and handed over my HSA debit card to pay for every medical expense I incurred. I cringe to think about this now.
My HSA Epiphany
During this one conversation with my office FI friends, my coworker mentioned that she not only maxes out her HSA, but also moves all that money into the investment portion of the account. She also doesn’t use the HSA to pay for any of her medical expenses, opting to use a credit card instead.
I thought this was insane. She is young and healthy, and can’t possibly need to be putting that much money away for medical expenses. Also, what investment option? We have an investment option? Turns out for a fee of $2 per month, this provider lets you turn on an investment account inside your HSA. This provider requires you to keep a balance in the cash account, but anything over that limit can be automatically swept into the investment account.
She went on to explain, answering questions I didn’t even know I had. You contribute pre-tax dollars, it grows tax-free, you withdraw it tax-free for qualified medical expenses, and you get to keep it forever. Then she explained the real magic of HSAs, which I will dig into below. She wasn’t the one making insane investment decisions, I was. I had left thousands on the table by not taking advantage of this sooner.
Making the most of an HSA
Contribute the maximum allowed amount to your HSA. Contributions are made with pre-tax dollars, lowering your taxable income and letting you keep more of your own money in the end. Below are combined contribution limits.
|Contribution limits |
(you + employer)
“Pay yourself first” is one of those sayings many of us have heard dozens of times. It never meant much to me. It was just one of those vague phrases I never thought much about. Of course I have to pay myself first, how else would I have money to pay other people? I’m a natural saver, so I also assumed this meant to put money into savings before discretionary spending.
It was watching David Bach’s course Start Late, Finish Rich on CreativeLive that made me think about this phrase in a new way. Paying yourself first isn’t just putting money into savings. It is trying to keep as much of your pre-tax income as possible. You are paying yourself first, before paying the government.
A Pay Yourself First Example
Let’s take a hypothetical person earning $75,000 a year in 2019. For simplicity, I am not going to look at deductions other than 401(k) and HSA. I will also assume maximum contributions of $19,000 for 401(k) and $3,500 for HSA.
|Taxes||Take home |
|Yours to keep |
|401(k) + HSA||$22,500||$13,654||$38,846||$61,346|
Paying yourself first really does pay. These pre-tax payroll deductions mean you effectively end up with thousands of dollars more that you get to keep and grow.
Invest your HSA dollars. HSAs consist of a cash account an an investment account. The cash account generally earns a low interest rate, while the investment option lets you choose how to invest those dollars. I have 100% of my HSA invested in VTI (Vanguard’s Total Stock Market ETF).
Do nothing. Seriously, don’t touch this account yet. We’re just going to sit and watch all those pre-tax dollars and tax-free growth accumulate. Pay for medical expenses with after-tax dollars for now. I pay for all of mine with credit cards to get points and miles. In the meantime, keep all your medical receipts – we may need them later.
Step 4 and Step 5 are my favorites. This is why I call this my “HSA IRA”. Please do not ask your financial professional about setting up an HSA IRA. They are not real things. It is just what I call mine based on how I plan to use it.
You have retired! Great job! We will now start treating our HSA like an extra Roth IRA. Remember all those medical bills we’ve been saving since opening the HSA? We can now use those to reimburse ourselves as needed. This money went in pre-tax, grew tax-free for years, and is now being withdrawn tax-free since it is for qualified medical expenses. It doesn’t matter if the medical bill is from 2 days or 20 years ago as long as your HSA was already open.
Happy 65th birthday! We will still continue to withdraw money tax-free from our HSA for medical expenses, but now we’ve earned a new perk. Once you turn 65, you can also treat an HSA like a Traditional IRA. You can withdraw that money for any reason and pay normal income taxes on it. So now our humble HSA is acting as both a Roth and a Traditional IRA. Pretty great, right?
I mentioned before that you get to keep your HSA, but what happens when you lose your HDHP insurance?
I am very fortunate that I just got an opportunity to drop my current coverage and be added to a new family HDHP plan through my spouse’s employer. Not only do they cover all insurance premiums, they also contribute $3,000 a year to the family HSA. Jackpot. But this also meant I had to figure out what to do with my individual HSA.
After dropping my employer’s HDHP plan, my HSA provider began charging a $5 per month account maintenance fee in addition to the $2 monthly investment fee. I needed out.
It didn’t take long to choose Lively as my new HSA provider. Lively HSAs are 100% free for individuals or families. No management fees. No investment fees. There is also no required minimum balance to be held in the cash account. I moved my entire balance to the investment account and put it all in VTI. My old provider charged me with a hefty $25 fee for closing my account, but they would’ve taken that as fees within four months anyway.
When my friend introduced the power of HSAs to us, she also assigned required reading – The Mad Fientist’s excellent article on HSAs. It is a great read – highly recommended.