Health Savings Accounts: How to get the most out of your HSA

The IRS just announced that health savings account contribution limits are going up next year! So, what does that mean for you? Well, this is money that you can actually use for everyday healthcare needs, while also receiving a tax benefit. It also has the potential for long-term investment growth with a triple tax advantage.

How do you use this type of account? Let’s clear things up. You can fund this kind of account using tax-deferred dollars, and that money can only be used tax-free for qualified healthcare expenses including medical visits, medicines, and even things like pimple patches and glasses. Don’t get HSA’s confused with Flexible spending accounts (FSAs). HSA funds are for saving while FSA funds are for spending. Contributions to an HSA are deductible from your taxes and, depending on the plan, unused funds in the account can be rolled over each year, allowing them to accumulate tax-free until they are used.

You MUST be covered by a high deductible health plan to make HSA contributions, but for the over 50% of Americans who are able to make these contributions, this increase in limits is huge! Exactly how big are we talking? The IRS announced that starting next year, someone with an individual health savings account will be able to contribute up to $4,150 to their account each year. This is up from $3,850 this year. And individuals with high-deductible insurance plans covering multiple people (like their children or their spouse) will be able to contribute up to $8,300, a big jump up from this year’s $7,750.

Now that contributions are going up, there are three ways you can maximize an HSA’s potential. The right choice depends on your personal situation.

1. Contribute the amount of out-of-pocket medical expenses you expect to incur in a year and use it as needed.

Factor in the different types of healthcare costs you are likely to incur and determine the amount you should contribute each year. Your out-of-pocket medical costs will vary depending on your individual situation, but there are some common categories that you should consider. These include deductibles, copayments, coinsurance, prescription medications, dental care, vision care, and other health services like physical therapy or chiropractic visits. All of these items add up quickly and can easily exceed your annual health insurance premiums.

If you contribute this estimated amount to an HSA, you’ll get two of the three HSA tax benefits: deductible contributions and tax-free withdrawals. Your balance would remain relatively small, so you wouldn’t get much of the other benefit; tax-deferred investment earnings. Another advantage of HSAs aside from taxes is that if you overestimate your expenses for the year, you won’t forfeit the balance. With flexible spending accounts, there are use-it-or-lose-it rules.

2. Contribute enough to cover your expected medical expenses—and then some.

Aim to build the account to completely cover one or more years of maximum out-of-pocket costs. Only take from the account for large or unusual medical expenses. You can handle the routine ones. Doing this helps you establish a reserve over time in case of a major health expense.

Take into consideration any existing health insurance coverage when deciding how much should be contributed annually into an HSA. Evaluate what kind of out-of-pocket costs your current coverage will pay for as well as any other considerations such as prescription drugs or co-pays associated with medical visits before deciding on an amount for your contribution. Knowing what is covered and having an estimate of what might need to be paid out of pocket is key before committing funds into an HSA.

3. Contribute at or near the maximum and invest most of it for the long term.

If you are able to make the maximum contribution, it affords you the full triple tax benefit. For 2023, contribution limits are $3,850 for individual coverage and $7,750 for family coverage. With this approach, you should have an investment strategy for your HSA, just like you do for a retirement account. Because earnings in an HSA are tax-free if used properly, you may want to invest the HSA more aggressively early in your career. Leading up to and during retirement, you may want to shift your investments to a more conservative mix. Ultimately, you’ll want to draw down this account in retirement.

The type of account opened will dictate the type of investments that may be available. Plans provided through banks usually offer only high-yield savings deposits. Brokerages offer much more. Some of the most popular brokerages are Vanguard, HSA Bank/TD Ameritrade, Lively, or Optum Bank. Check with your HSA plan to see what options are available.

We know that investing money you might need to access for a medical emergency might make you uneasy. This strategy doesn’t need to be an all-or-nothing approach. You can invest a portion of your HSA contributions and see them grow over time, while keeping an amount of it more conservative- depending on your timeframe and risk tolerance.

What’s the bottom line? No matter how you choose to use your HSA, it makes dealing with our less-than-ideal healthcare landscape just a bit easier. So why not give your retirement a boost while you can!

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