Health savings accounts (HSAs) are particularly prized for their triple tax advantages:1 Contributions are tax-deductible, earnings are tax-free, and withdrawals are tax-free when used for qualified medical expenses. However, roughly 88% of HSA holders keep their accounts entirely in cash, according to the Employee Benefit Research Institute. Account holders who don't invest their HSA contributions could be missing an opportunity to earn tax-free returns.
"We generally suggest keeping two to three years' worth of routine medical expenses in cash, cash investments, or similar low-volatility investments within your HSA," says Rob Williams, managing director of financial planning, retirement income, and wealth management at the Schwab Center for Financial Research. Then, any excess funds could be invested for potential growth—for two reasons:
- Given the likelihood that health care costs will be even higher in the future, doing all that you can to get ahead of them is wise. Indeed, a 65-year-old couple retiring today can expect to need as much as $318,000 in savings to cover Medicare premiums and out-of-pocket costs throughout retirement.2
- After age 65, you can use your HSA to pay for things other than health care.3 You'll owe ordinary income tax on the funds with no other penalty—similar to withdrawals from 401(k)s and IRAs. However, HSAs aren't subject to required minimum distributions, making them a compelling option for retirement savings overall.
To contribute to an HSA, you must participate in an eligible high-deductible health care plan—often, but not always, offered through an employer. For an individual account, you can contribute up to $3,850 in 2023 ($7,750 for families), plus an additional $1,000 in catch-up contributions if you're 55 or older. Contribution limits increase to $4,150 (individual) and $8,300 (families) for 2024.
Most HSAs require you to maintain a minimum cash balance before you can open an investment account. Once you have sufficient funds to meet your minimum and cover health care costs, you can start investing some of your contributions based on your risk tolerance, your time horizon, and, ideally, a diversified portfolio or other investment choices offered by your HSA administrator.
1While HSA contributions, earnings, and qualified distributions are exempt from federal income tax, they may not, in whole or in part, be exempt from state taxes.
2Jake Spiegel and Paul Fronstin, "Projected Savings Medicare Beneficiaries Need for Health Expenses Remained High in 2022," ebri.org, 02/09/2023, www.ebri.org/content/projected-savings-medicare-beneficiaries-need-for-health-expenses-remained-high-in-2022.
3Nonqualified withdrawals made prior to age 65 are subject to ordinary income tax plus a 20% early withdrawal penalty.
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