An HSA, or a Health Savings Account, can be one of the most exciting financial tools if you know how to use it.
It offers a triple tax benefit.
The money you contribute to your HSA gets deducted from your taxable income. Any money you earn from the savings or investment component remains tax-exempt at least until you make an HSA withdrawal and spend the cash. And when you use the money on qualified expenses, you get to spend it tax-free.
Healthcare can get prohibitively expensive late in life. Especially if you live a long time. So stockpiling money in an HSA throughout your career, investing it and enjoying tax-free growth can give you a huge advantage.
However, the investment component of HSAs can be confusing. It’s not a frequent topic of discussion in personal finance.
How does it work? And what happens if you need to make an HSA withdrawal? That’s what a listener of the Clark Howard Podcast recently asked.
How Can I Invest in My HSA While Maintaining the Ability To Make an HSA Withdrawal?
Most people don’t invest inside of their HSA accounts. As of October 2021, about 91% of HSA account holders didn’t have a single dollar invested.
“Almost no one invests their HSA money. They don’t even know how to do that,” Clark says. “An HSA is the equivalent of a savings account. But if you’re someone who can let that money build over the years, you don’t want it sitting in savings. You want it invested.”
But what happens if you need your HSA investment money to pay for a health issue — or some other curveball that life throws at you? That’s what a listener asked on the Dec. 6 podcast episode.
Heather in Pennsylvania asked: “I will be trying a high-deductible health plan and HSA for the first time. What do we invest the funds in that is productive, but liquid enough to allow us to take money out if needed? I would like to just use my savings and defer the HSA money for the future, but you never know what will happen in the present.”
HSA Withdrawal Rules: Penalties, Taxes and Qualified Expenses
To clarify, you can withdraw from your HSA and spend the money on qualified medical expenses at any time. You won’t be penalized or taxed.
Your HSA investments aren’t locked. You can sell and then withdraw the money the same as you could via an investment account or IRA.
However, if you withdraw the money before 65 years old and use it on something other than a qualified expense, not only will the IRS consider those dollars to be taxable income, but it will also levy a 20% early withdrawal penalty on you.
Once you’re 65, you can withdraw the money and spend it on anything you want. Non-qualifying expenses will still count as taxable income. But they won’t usher in a 20% IRS penalty.
How To Structure Your Savings and Investments Inside Your HSA
Back to Heather’s question. Don’t view saving or investing within your HSA as an all-or-nothing proposition, Clark says.
“If you’re not confident and comfortable that you could safely invest all the money, you don’t invest $0. Try to invest half of what you’re putting into the HSA each month,” Clark says. “You get the benefit of half of your money having long-term growth and the other half being available for more current medical expenses.
“If you get several years into an HSA and you find that you’re not tapping into the reserve funds, then years moving forward, you leave the money [that’s] already sitting in [a] money market. But in the future, all the contributions would go into [an] index fund.”
Even if you get an HSA through your employer, you aren’t obligated to invest through the option that your health insurance company provides. These companies offer “horrendously terrible high-cost plans” and “are incredibly awful choices for any form of investing for the future,” Clark says.
Clark recommends moving your HSA to Fidelity Investments or Lively because of their low-cost plans.
But again, you can feel safe investing money inside an HSA to the extent that you’ll be able to sell your investments and spend that money on qualified health expenses should you need to do so. It’s not like the funds you put into a 401(k) account, which are totally locked until a certain age (or else you must pay huge penalties to the IRS).
Final Thoughts
An HSA is an outstanding way to invest for your future health expenses. You can also use HSA money to pay for your healthcare now.
The triple tax benefit is one of Clark’s favorite financial tools.
Even if you invest inside your HSA, and then need to sell those investments to pay for qualified healthcare expenses, you won’t face taxes or penalties.
Just make sure you’re investing through a low-cost HSA plan provider.
