Health savings accounts are an incredibly tax efficient way to fund medical expenses, and there are some creative ways to use these accounts to get the most out of them.

The Tax Advantages of an HSA

There are three distinct tax advantages to HSA’s:

1. Contributions to the account are tax deductible.
2. Earnings on investments you hold within the account are tax deferred, meaning you don’t pay taxes if your investments pay out dividends or capital gains like you would in a normal brokerage account.
3. Withdrawals of contributions and earnings from the account are tax free if you use them for qualified medical expenses.

For example, if you contribute $1,000 and we assume you are in the 22% tax bracket, you would save $220 in taxes that you would have had to pay on that income. 

Let’s say you invest that $1,000 and it grows over time to $1,500. If you had saved this money in a taxable brokerage account, you would owe capital gains tax at a rate of 15% on the $500 of earnings ($75 of taxes) when you withdraw the money.

By using the HSA and spending the $1,500 on qualified medical expenses, you end up saving $295 in federal taxes – $220 on the initial contribution, and $75 on the investment gains.

How it Works

Many employers who offer a high deductible health plan may also offer an HSA to go along with it. You can make contributions directly out of your paycheck. Some employers even contribute money to your account as an extra perk. You can also open an HSA on your own if you are eligible but your employer doesn’t offer one.

Although the account is only held in your name, it can also be used to pay medical expenses for your spouse and dependents.

As with any account that comes with tax advantages, there are certain rules and limitations to be aware of:

Are you eligible: You need to have a high deductible health plan and meet some other criteria to be eligible to contribute to an HSA. For 2023, this means a plan with a deductible of at least $1,500 (individual) or $3,000 (family) and out-of-pocket maximums of less than $7,500 (individual) or $15,000 (family), although amounts change each year. You don’t need to have a high deductible plan at the time you withdraw the money.

Contribution limits: Annual contributions are limited to $3,850 for individuals or $7,750 for families (for 2023). Limits increase by $1,000 if you’re 55 or older. These limits take into account both your contributions and any contributions your employer makes.

Withdrawal restrictions: Typically, taking withdrawals that are not used for qualified medical expenses means you pay taxes and a 20% penalty on the distribution.

However, if you wait until you are 65 or older, you can withdraw the funds for any purpose and you will only pay income taxes on the withdrawals. This means after 65, your HSA distributions are taxed at your ordinary income tax rate, in the same way as your traditional IRA or 401(k) distributions.

And one big benefit of an HSA over an FSA is that there is no “use it or lose it” aspect to HSA’s – the money is yours to spend whenever you need it and even stays with you if you switch jobs.

Planning Opportunities for your HSA

If you really want to maximize the tax advantages of your HSA, here is how you make it happen:

Invest the money for long term growth. Many HSA’s allow you to invest in diversified, low cost funds, and this is your best bet to allow the money to grow over time. Your time horizon will determine how aggressively you should invest.

Don’t withdraw the money now! Pay your expenses out of pocket and allow your money to grow. Don’t use the funds in your HSA for current medical expenses – whenever possible, pay costs out of your current cash flow and allow those HSA funds to grow. And don’t underestimate the benefit of being able to use the funds for any expenses without penalty after age 65. Your HSA can function as another tax deferred retirement account if you can’t use all the money for medical expenses.

Save your receipts and use those medical expenses you have today to withdraw money years into the future. The money in your HSA does not need to be withdrawn in the same year as an expense was incurred. If you can leave the money alone and allow it to grow for years (or better, decades), you can use those expenses you have today to withdraw money tax free down the road. Set up a free gmail account and email all of your receipts to yourself or create an album in the photos app on your phone so you can find them easily in the future.

By using these tips, you’ll get the most bang for your buck from your HSA account and maximize your tax savings.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

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Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.