On this episode of the Millennial finance podcast Financially Well, I’ll talk about health savings accounts, or HSAs. In particular, I’ll review why an HSA is worth it for many Millennials who want to grow their wealth. Based on a recent article from Christine Benz, I’ll also discuss how you can minimize any concerns you may have about investing in a health-specific account.
Christine Benz writes about personal finance for Morningstar. And on September 29, she wrote an article entitled, “Can You Save Too Much in a Health Savings Account?” In the article’s first few paragraphs, she writes:
“HSA assets have taken off since [their creation in 2003], mirroring the growth of high-deductible healthcare plans at large…. At mid-2021, assets in HSAs approached $93 billion, a 26% increase from the year prior.”
As HSAs have become more common, Millennials increasingly wonder whether they should add yet another account to their personal finance wish list. This feeling may be particularly powerful for people who still can (and want!) to contribute more to retirement accounts, such as a 401(k) or IRA. We already have enough accounts to catch up on, right? More does not always equal better, especially for Millennials who already feel stressed about their investment to-do list. But HSAs actually do offer benefits that arguably make them superior to the investment accounts you already know. Unfortunately, too many young adults haven’t heard about these details. Or they’re not using the HSA in a way that maximizes its advantages.
So let’s try to give you some more clarity on why an HSA is worth it for your life and financial wellness.
First, though, I want to put Christine Benz’s reporting and data into context. I regularly discuss money with other Millennials, either as their financial advisor or through a financial wellness program. Many of these Millennials specifically reach out to me for investment guidance. But they typically ask for help with those more common investment accounts — 401(k)s and IRAs. Occasionally, one of my clients will express curiosity about the potential value that HSAs offer. Rarely, though, have they already opened or contributed to these accounts.
More often, I hear Millennials confuse HSAs with FSAs, or Flexible Spending Accounts. They know that FSAs come with a use-or-lose-it dynamic. And they may already be struggling to remember to spend down their FSA contributions — hello, CVS! — by the end of the year. In this case, they’re probably not too interested in dealing with a similar account.
But HSAs don’t have a requirement that you spend those dollars in the near-term! In fact, much of the financial power in HSAs stems from the fact that you can invest most of the dollars you contribute. This is the second aspect of HSAs that seems to throw off many Millennials. Did you realize that an HSA functions much like the 401(k) or IRA that you already use? In other words, once you contribute to the account, you can invest those dollars for the long term in low-cost, diversified index funds.
With these features in mind, let’s clarify how HSAs can play such a meaningful role in your financial progress.
If we can invest HSA contributions, we can take advantage of the compounding growth that the stock market offers. But to benefit from compounding, those HSAs dollars need to stay in that HSA account. Ideally, you won’t use an HSA like you use an FSA. If you have a medical expense that insurance doesn’t cover, you should try to pay for that expense out of income or existing cash savings. I recognize that this isn’t feasible for everyone in all situations. But the more money you can contribute to and leave in that HSA, the more you will benefit from compounding over the long term.
That statement becomes even more powerful when I add in the tax benefits that HSAs include. You may read a blog or hear a financial expert that refers to HSA as possessing “triple tax benefits.” How so? Well, like a pre-tax 401(k) or IRA, you don’t pay taxes on the income that you contribute to the HSA. Then, also like those retirement accounts, you don’t pay taxes on any investment growth that takes place over years and years. And finally — unlike pre-tax 401(k)s and IRAs — you don’t pay taxes when you use the money, if you spend that money on “qualified medical expenses.”
For anyone who still wants to max out their retirement accounts in the years ahead, that last sentence may give you pause. You may think, “I’m not sure I want to prioritize a health-specific investment account.” But unlike, perhaps, a college savings account, we know with a high-degree of certainty that we will all have medical expenses later in life. Without an HSA, you may find yourself using 401(k) or IRA dollars to cover those costs anyway. With an HSA, you’re free to use those dollars in different ways.
But let’s assume there’s still some uncertainty and risk in funding an HSA relatively early in life. Here’s the aspect of Benz’s article that I value most: she details “two key ways to get your money out sooner without negating the tax benefits of the HSA.”
Firstly, she writes, “If you paid out of pocket (using non-HSA assets) for healthcare expenses in previous years, you can still make a tax-free withdrawal later on for non-healthcare expenses, provided you hung on to receipts for the earlier healthcare costs.”
Secondly, after age 65, Benz notes, “If the withdrawals are for non-healthcare expenses, they’ll be taxed exactly as an IRA or 401(k) withdrawal would be. In other words, you’ll pay taxes on your withdrawal, but you’ve been able to take advantage of a free ride on taxes up until that point.”
An HSA may not seem exciting. Particularly compared to a more open-ended brokerage account or even the retirement accounts that you already know. You don’t feel like you’re going to use those investment dollars to buy a beach house in retirement, right? Yet, you may not want to miss the HSA’s tax benefits and withdrawal flexibility. And also keep in mind: there’s a high probability that most of us will have significant medical expenses later in life. Taken together, the HSA rises to become a top investment account for many young adults.
I hope Benz’s article, and my HSA discussion here, empowers you to reconsider why an HSA is worth it for your personal financial wellness. But also keep this relatively unique dynamic in mind: the federal government currently ties HSAs to high-deductible healthcare plans. As a result, an health savings account may not actually work for your life, even if you admire its benefits. First and foremost, you’ll likely want to prioritize a healthcare plan that suits your personal health circumstances. This consideration rules out a high-deductible healthcare plan for some people, and, by extension, an HSA. Tax savings and compounding growth are great, but not when you jeopardize your healthcare coverage in pursuit of them.
Check out Christine Benz’s article at Morningstar. Again, it’s called “Can You Save Too Much in a Health Savings Account?” I encourage you to her writing and support her on social media. And, of course, subscribe to this Millennial finance podcast to learn more about how you can improve your own financial wellness.
[Editor’s note: this article reflects the transcript (which I’ve edited for clarity) of a recent Financially Well podcast episode.]
Kevin Mahoney, CFP® is the founder & CEO of Illumint, a Washington, D.C.-based company that offers financial planning for Millennials. He specializes in navigating the new financial decisions that arise during our late 20s and 30s, such as repaying student loans, buying a house, saving for college, & learning to invest. In addition, Kevin also works as a financial wellness program provider to Millennial employees around the country, including group speaking engagements.
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