Should I use my HSA to pay for medical expenses or save it and pay out of pocket?
This is a very common question once people make the decision to enroll in an HSA. First I want to clarify something that's often confused and gives us a hint at our answer. HSA stands for Health Savings Account, which is different from a Flexible Spending Account. Both accounts are common and easily mixed up, as most people assume the S stands for the same thing!
Now there are two very different answers to this question, depending on:
Your financial stability
Your medical expenses
Answer A: If you don't have savings available that you can easily reallocate to pay for your healthcare expenses, use the money in your HSA to cover your medical bills.
Answer B: If you have savings you can rely on to pay for healthcare expenses, consider paying your medical bills out of pocket and using your HSA as a retirement account to grow your wealth.
Now I'll go into more detail so you can figure out what makes the most sense for you.
When to use your HSA for medical expenses
You're probably thinking, "Okay that's obvious. If I have medical expenses and don't want to dip into my emergency fund or take on credit card debt, I'll use my HSA. But what are the costs and benefits of using money in my checking or savings account versus the HSA?"
The benefit of using your HSA to pay for medical expenses is that you're withdrawing money from an account that won't be taxed. That money was also never taxed when you contributed to it in the first place. So when you withdraw that money to pay for health expenses, you're using an entirely tax-free source. This enables you to make the most of that income while covering your health costs.
The downside of withdrawing from your HSA is that you're tapping an account that is optimized for tax free growth, like a Roth IRA. Health Savings Accounts are actually the most tax-advantaged investment account you have access to! You may have heard that HSAs offer a "triple tax advantage." This means:
The money you contribute is tax deductible
The money that grows in the account is tax-deferred
The money you withdraw for qualified medical expenses is tax-free
This triple tax advantage is magical. By taking money out of the account, you sacrifice the opportunity for decades of tax-free growth compounding.
One approach that I find helpful for deciding how to spend HSA money is to define what a "significant medical expense" means for you, and only use your HSA to cover those costs:
My personal approach…
My partner and I have an HSA and decided to set a percentage threshold where if medical bills exceed that % of our household income, we are okay to use those funds to reimburse ourselves. Otherwise, the money stays in the account to grow.
Several years ago I had a minor surgery that cost $3,000. We opted to cover that bill out of pocket (ouch!), but the $3,000 we could have used in our HSA has stayed invested and grown. We can always choose to reimburse ourselves in 30+ years for the surgery since we kept all our receipts.
I'd recommend setting up some guidelines for you and your family ahead of time. You never want to prioritize investing above seeking medical care.
When to use your HSA as a retirement account
If you don't have what you would consider to be significant medical expenses, you should take advantage of the HSA as a retirement account, which will allow you to fund your health care costs later in life. This means paying for health expenses out of pocket today, and then saving your HSA contributions each year.
An important caveat is that you need solid financial footing—emergency savings and a steady, predictable cashflow—to be able to use this. Just because you don't have major health costs now, doesn't mean you won't in the near-term.
The greatest benefit of using your HSA as a retirement account is the investment option. Unfortunately, this is something that many HSA owners miss. Health Savings Accounts default to cash balances. However, you have the option to invest that cash for long-term growth! This is critically important to making the most of your HSA.
After an employer match to your 401(k), the HSA is the most tax advantaged way to save for medical expenses during retirement, because of the triple tax savings I mentioned before.
How HSA investment strategy works:
Annually contribute as much as you can (max is $3,600 single, $7,200 married) - which lowers your taxable income!
As the cash accumulates, be sure to continuously invest your account balance and pay your health expenses out of pocket.
Over time, your HSA balance will grow and compound. Be patient and stay invested!
After only a few years of saving and investing, it's likely that an HSA owner could have 2-3x the amount of their annual "high deductible" set aside. The dedicated account offers peace of mind around healthcare expenses not only for today, but for the future when your healthcare costs are likely to be more expensive.
Choose the right health insurance for your needs
Beyond the major tax benefits, the HSA also offers a lot of flexibility:
There are no time limits on reimbursing yourself for medical expenses. You always have the option to withdraw money tax-free for current or past health expenses. Just be sure to save all your medical receipts.
At age 65 you have the option to begin using your HSA balance just like an IRA. You'd lose the tax-free withdrawal benefit if you use the funds on non-medical expenses, but only owe ordinary income tax on the distributions.
You can even let the investments grow in the HSA over the course of your entire life and withdraw late in life to pay for expensive long-term care or nursing costs.
One final thing to keep in mind is that you don't have to commit to your High Deductible Health Plan and HSA forever. I've had clients anticipate high healthcare costs in certain years for family planning, therapy, surgeries, etc. At open enrollment that year they set aside their HSA and opted for more traditional health insurance, like a PPO or HMO. You can leave the HSA balance invested and come back to it in future years.
I hope this has been helpful as you think about your health and saving for your future!
Curtis
