How to Use a Health Savings Account (HSA) to Build Wealth

My cousin has a plan to become a mega-millionaire using his health savings account (HSA). Unconventional? Maybe not. An HSA can offer a reliable investment strategy — as long as you use it to your advantage.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

Let's explore the ins and outs of an HSA and how you might use it to build your nest egg.

What is an HSA?

First things first. An HSA, a type of savings account, allows you to put money aside on a pretax basis to pay for qualified medical expenses. In other words, untaxed money in your HSA will pay for medical expenses and allow you to pay less for your overall health care costs.

You can contribute to an HSA only if you have a high deductible health plan (HDHP). An HDHP has a higher deductible than a traditional insurance plan. You'll usually pay less for your monthly premium but you pay more health care costs out of pocket before your insurance company pays its portion. In other words, you must pay a higher deductible — the amount you pay before your insurance kicks in (hence, the reason for the name of the account). Ultimately, your HSA allows you to pay for certain medical expenses without paying federal taxes.

How HSAs Work

This year, to qualify as an HDHP, plans must carry a minimum $1,400 deductible for individuals and $2,800 for families. Maximum out-of-pocket limits for HDHPs must go up to $7,000 for individuals and $14,000 for families. You can save up to $3,600 as an individual to an HSA in 2021 and families can save up to $7,200. In addition, you can contribute an additional $1,000 if you are age 55 or older. 

Once you collect money in your HSA, you can invest it without paying taxes on your capital gains and dividends. As long as you use the money on qualified healthcare expenses, you don't pay taxes on the money you take out of an HSA. 

At the federal and state levels, your contributions don't get taxed in most cases and earnings and interest grow tax-free (again, this remains the case in most states). 

How to Invest the Money in Your HSA

Here's where it gets interesting. If you don't spend the money in your HSA on medical expenses, you can take it out and use it for anything you want (including to supplement your retirement) without a penalty starting at age 65. You'll just have to pay ordinary income tax rates on the money you take out. 

Learn more about how to invest the money in your HSA in just a few steps.

Step 1: Sign up for an HSA. 

Learn more about your HSA and HDHP options through your employer. You can also open an HSA even if your employer doesn't offer one. However, you must have an HDHP as well. You can search for an HSA through a bank, broker, credit union or insurance company. You may want to talk to a licensed broker or financial advisor so you understand all of your options. 

Step 2: Check into your investment options. 

You can put your HSA money into more than just a low-return savings account. You can invest in stocks, bonds, mutual funds and ETFs, for example. Putting your money into investments with the potential for higher returns can offer you a great long-term savings and retirement strategy.

Step 3: Learn about fees.

HealthSavings Administrators, a popular provider, doesn't charge investment transaction fees, so you won't get hit with unexpected fees as you save. 

However, HSA providers typically charge the following fees, which can eat into your profits:

• Administrative fees: Your provider charges this fee to administer your HSA.
• Investment fees: HSA providers charge this fee to allow you access to investments.
• Transaction fees: You'll pay these fees when you make specific account-related actions. For example, you may try to make a purchase with nonsufficient funds or you may need to make a correction to an amount you purchase. In both cases, you'll pay transaction fees.

Step 4: Don't use your earnings to pay for health care expenses.

If you want to use your HSA as a savings vehicle, you won't use it to pay for ongoing health care expenses — you'll leave it alone and let it grow. 

You don't have to reimburse yourself for medical expenses by a specific date. This means that if you pay for eligible medical expenses out-of-pocket, you can wait 10, 20 years or longer before you reimburse yourself. You let your principal investment grow through compounding interest and overall investment earnings.

At that point, you can use the money on whatever you'd like and not pay taxes on it.

Step 5: Monitor your accounts.

Know what's going on in your accounts. You must monitor your contributions to ensure they do not exceed the annual contribution limit per IRS regulations.

Have HSA funds in another account from a previous job? You can transfer funds from or roll it over to another HSA as well. When you consolidate your accounts, monitor your contributions to ensure they do not exceed the annual contribution limit per IRS regulations.

Bottom line: Know what's going on in your account so you get the most out of it over the years.

Step 6: Withdraw your money in retirement.

Prior to turning 65, you pay income tax plus a 20% penalty if you don't use your money to pay for qualified medical expenses. However, once you turn 65, that 20% penalty no longer applies, so you can withdraw penalty-free for nonqualified expenses. However, you do still have to pay the income tax on the distribution.

Note that once you enroll in Medicare, you can no longer fund your HSA.

Use Your HSA as a Retirement Savings Vehicle

It's easy to identify some huge attractions to using your HSA as a retirement vehicle. The tax-deductible options, tax-free growth and flexible withdrawal options can help you in retirement and pay for qualifying medical expenses.

This all works out well because, after 65, you'll probably need your HSA most during these years. However, no matter what, remember to make eligible purchases — it's the only way to fully avoid all penalties.