Investment 101: How to Use the HSA to Your Advantage

by Nicole
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Thanks for visiting my series on investments. This is part 4 of the series. If there is a topic you would like to be covered, please let me know.

To read part 1, “Investment 101: How the 401K Can Increase Your Wealth”, click here.

To read part 2, “Investment 101: How Compound Interest Can Make You a Millionaire”, click here

To read part 3, “Investment 101: What is an IRA”, click here.

HSA: A Powerful Tool

If you’ve been following the investment 101 series, by now you’ve read about the 401K, IRA, and now you are about to be amazed at the tax benefits of the HSA. A health savings account (HSA) is a tax advantaged account available for those individuals enrolled in a high deductible health plan. 

 

The HSA is an incredibly powerful investment tool because you can contribute tax free money (like the traditional 401k/IRA) and then let that money grow tax free. Essentially, the HSA is the best of both worlds because the money is not taxed when you put it into the account or take it out. The only instance where your money would be taxed is if you take the money out for non qualified medical expenses. However, even if this is the case, the account acts as a traditional IRA which is still a huge benefit which I’ll explain down below. 

Eligibility

You must have a high deductible health plan. Don’t worry, this article is NOT about insurance so don’t go running away just yet. Trust me, as a health care provider the worst part about my job is understanding insurance. The HSA isn’t about insurance though, it’s just another tool to make you wealthy. 

These high deductible health plans come at a lower upfront premium cost but, as the name implies, have a higher deductible. This type of health insurance works well for young, healthy folks who rarely go to the doctor. The government put the HSA in place because they realized that most people can’t afford the large bills that come with having a high deductible health plan. Therefore, the HSA can serve as a tax advantaged savings account for medical bills. If you’re looking for a true healthy profit though, you’ll use this account as a long term investment vehicle which we explain in the next section.

2 Ways to Use the HSA

1. Use the money now to pay for medical expenses

Example: if you go to the doctor and the bill is $150 you can use the tax free money from your HSA to pay the bill.

This is the simplistic way to use the account and this was what it was designed for. Medical bills can add up fast and it’s hard to foresee those expenses. This account essentially forces you to save for medical expenses and comes with a great tax benefit.

To view common items the IRS qualifies as medical expenses, click here. Common items such as OTC allergy medication, eye drops, feminine hygiene products, and eyeglasses all count. You’ll be amazed at how many items and appointments qualify.

If you choose to utilize this option, your HSA provider will send you a debit card which you can use on any qualified medical expense. The money will be taken directly from your HSA at no extra expense. There is also no penalty on using this money prior to age 65 as long as it is spent on qualified medical expenses. I would suggest keeping all your receipts and keeping a detailed spreadsheet regardless just in case the IRA ever audits you.  

In summary when you use this method, you spend money BEFORE you pay taxes and this matters because the money on this debit card is TAX FREE MONEY.

2. Invest the money for the long term

This is the healthy profit option; its what I do and it’s what will provide you with the best outcome. 

This is the most optimal way to use the HSA because, remember, you got the tax deduction when you contributed money and this money will continue to grow tax free. The more money you have in this account to grow tax free, the more compound interest will work in your favor! 

If you choose to use the HSA in this fashion you’ll have to pay all your medical expenses out of pocket now but save all the receipts to be reimbursed later!  You can still withdraw money tax free from the HSA at any point with no penalty as long it is spent on a qualified medical bill

A fellow blogger made this incredibly simple list which outlines all the qualified medical expenses. You can find that here

Once you turn 65, the funds can be taken out for non-medical expenses however we suggest leaving it in the account for as long as possible so compound interest can continue to work in your favor. 

I know what you’re thinking…what if we don’t expect to use all our HSA money on qualified medical expenses. Here’s the answer: any money that is left after paying off medical expenses from all those years will be taxed at whatever your tax rate is (acting like a traditional IRA) which is still a huge advantage as opposed to a non tax advantaged brokerage!

The goal of this video is to show the layering effect. Contributing to an HSA tax-free and investing the money you don't use eliminates the drag of taxes on your growth. This will compound fast!!!

This idea came from one of my favorite easy to read books on personal finance, “I Will Teach You To be Rich“, by Ramit Sethi.

Purchase your copy of his book, here

The chart came from a fellow finance blogger. You can read his rendition of explaining the HSA here

Action Steps

  1. Confirm your are on a high deductible Health plan.
  2. Ensure your company offers an HSA. Your employer may even offer a match.
  3. Sign up to have contributions come directly from your employer through a payroll deduction.
  4. Contribute as much as you can. The max for 2020 is $3,550. Note that unlike the 401k, the employer match is included in the max contribution.
  5. Once you’ve contributed you need to invest this money. My advice would be a low cost equity index fund or a target-date fund. Note that if you plan on using the HSA for medical expenses in the near term, you may not want to invest in equities given the volatility of them. Perhaps in this case invest in a money market account or short term bonds. 
  6. Track each and every qualified medical expense. 
  7. Choose how you will use your HSA (from option 1 or 2 above).
  8. Watch your MONEY GROW! (especially if you choose option 2).

Hopefully, this article makes the concept of an HSA a bit more simplistic for you. Don’t forget to watch the YouTube video above for a visual picture of how incredible this account is! Additionally, speak with your employer or HR representative for more details about your specific HSA provider.

As always, if you have any further questions drop them in the comments below or message me! I love to help. 

XO,

Nicole 

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[…] opened a 401k, you need to do that now! Prioritize tax advantaged accounts like the 401K, IRA, and HSA because it’s a use it or lose it scenario. The IRS only allows a certain amount of contributions […]

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