Should I Open an HSA? An HSA Deep Dive: How I Made a $500,000 Mistake by not Utilizing an HSA and how I am Fixing it
Have you ever reviewed your monthly pay stub and specifically looked over your health spending? My healthcare spending choice cost me $500K in investment growth by not properly strategizing. Don’t make the same mistake I did and research your health plans, and health spending, and build a lifetime strategy.
I have always chosen the HMO from my employers simply because it was the middle option as far as cost. High Deductible Health Plan (HDHP) seemed too little, PPO seemed too high, HMO seemed to be just right. If you are relatively healthy and do not often visit the doctor, then a High Deductible Health Plan paired with an HSA may be life-changing for your future self.
In the typical US household, healthcare and health insurance will be one of our highest lifetime expenses. I took the middle option for so many years primarily because I saw it as that happy medium, and realized too late that I left so much wealth growth potential on the table. It wasn’t until the last few years that I realized there was a much better option to allocate my healthcare budget.
I decided I needed to have a defensible answer to the question: What is the best Health Plan for my family?
The HSA paired with a High-Deductible Health Plan is one of the largest opportunities where Personal Finance and Healthcare intersect.
After researching and deliberating for quite some time we determined that this plan is not only more suitable for our family's current needs but has the potential to set us up for significant savings and earnings in the future. I have to caveat this with, we are a fairly “healthy” household. Meaning that we are blessed to not have any diagnosed health concerns and have not really had any reason to utilize our healthcare outside of standard checkups.
What is an HSA?
An HSA is a type of savings account that lets you set aside money on a pre-tax basis to help pay for qualified medical expenses that are not covered by a High Deductible Health Plan.
An HSA can help lower your overall healthcare costs by using untaxed dollars in to pay for deductibles, copayments, coinsurance, and other expenses.
For 2023, the HSA contribution limit is $3,850 for an individual and $7,750 for family coverage. Employees who reach age 55 by the end of the tax year can contribute an additional $1,000 as a catch-up provision.
Who can Participate in an HSA?
Anyone who is currently enrolled in a High Deductible Health Plan is eligible to participate in an HSA. When reviewing plans in the Marketplace, you can see if they’re "HSA-eligible." Some health insurance companies offer HSAs for their HDHPs, you just need to check with your company. You can also open an HSA through some banks and other financial institutions.
If you are claimed as a dependent on someone else’s tax return, you’re ineligible for an HSA. So parents can open one for their children, but children cannot open one for themselves if they are on their parent’s plan.
Self-employed individuals can also have access to an HSA. It is a misconception that only people who are employed by a company can participate. Anyone who is enrolled in a high-deductible HSA-qualified health plan can set up an HSA with an HSA account provider.
What are the Key Benefits of an HSA?
Triple Tax Break: First and foremost, the HSA offers a rare opportunity to bypass taxes.
Contributions are typically tax-deductible. HSA deposits are usually made with pre-tax dollars through your employer’s payroll or, if you are self-employed, they may be deducted on your tax return.
Earnings grow tax-free. The longer you are invested in an HSA, the greater the opportunity for your contributions to grow. Additionally, funds in an HSA are not “use-it-or-lose-it” like an FSA but can be used at any time. FSAs require users to spend the money within a certain period or those contributions are forfeited. This means that you may be able to save the funds in your HSA for retirement when your healthcare costs may be greater. This statement is the best-case scenario where there were no life circumstances that caused you to need to use the funds.
Qualified withdrawals are tax-free. HSA funds withdrawn for qualified medical expenses are not taxed. Qualified medical expenses include health insurance deductibles, copayment, diagnostics, prevention, and treatment of diseases (including mental illness), as well as medical equipment and supplies for you, your spouse, and your dependents. The IRS maintains a list of eligible expenses (IRS Publication 502) ranging from acupuncture to X-rays. Once you are enrolled in Medicare you can no longer contribute to an HSA, but you can continue to use the funds for medical expenses, including Medicare premiums. Keep in mind that you can not “double-dip”. Only eligible expenses that haven’t been reimbursed by another source (insurance or an FSA) support a tax-free withdrawal.
Triple Tax Advantage of an HSA
Portability: HSA’s will travel with you, they are your investment account. If you change jobs, you bring your HSA with you.
Transferability: HSA funds that are invested can be transferred to pay for approved medical expenses.
What risks are associated with an HSA?
If you are a higher utilizer of your healthcare, another type of medical plan may just make more sense financially.
All health expenses (visits to the doctor, medical procedures, prescriptions, etc.) must be paid for out-of-pocket until your deductible is met and your health insurance kicks in to pay.
The 2023 limit on out-of-pocket expenses (including items such as deductibles, copayments, and coinsurance, but not premiums) is $7,500 for self-only HDHP coverage (up from $7,050 in 2022), and $15,000 for family HDHP coverage (up from $14,100 in 2022).
How to maximize the benefit of the HSA.
Max contributions to your HSA every year
Invest contributions in low-cost equity index funds
Let it grow tax-free for decades
Spend as little of it as possible, as long as you’re reasonably healthy, to maximize HSA growth
Hold off on using the HSA to pay your healthcare-only expenses until retirement, or when you incur expensive medical expenses. If you’re able to keep your HSA funds in your account until age 65, the IRS no longer requires you to use the money for qualifying healthcare expenses. At that point, you can use your savings to supplement your retirement income. Just remember, withdrawals for non-qualified expenses would be subject to regular income tax.
Use other retirement accounts (401K, IRA, etc.) to pay your non-healthcare expenses
Let’s look at my Real World Example (mistake) by the numbers:
Let’s just look at a rough estimate of the opportunity cost of my mistake. I was spending roughly $400 per month ($4,800/year) on my company's HMO as a single person for 8 years and then $550 per month ($6,600/year) for another 4 years when we had kids and enrolled in a family HMO.
I visited the Doctor once in 12 years (not medical advice - always go to your doctor for an annual check-up!)… So in short, I threw $4,800 a year for 8 years ($38,400 total cash) and $6,600 per year for 4 years ($26,400 total cash). A total cash outlay of $64,800! This excludes the amount that the money could have grown if invested in an HSA.
All of that cash was essentially thrown into the garbage since I did not utilize the benefits whatsoever until we had kids and we had all of the doctors’ visits through pregnancy and toddler checkups. At least I had peace of mind? Time to show you why these already big numbers really, really hurt my heart. I will try not to cry while putting this together.
If we had invested that money in an HSA for that entire period, assuming we maxed out our HSA contribution, invested the extra money that was beyond the HSA Max (HMO $4,800 - HSA $3500 = $1700 to be invested) in an IRA, using a conservative 8% growth rate that money now would be worth $101,778. I have none of that because I dumped it all into the HMO that I did not utilize.
Just to really drive home why this hurts so badly, let’s see what happens to this investment in 20 years. Since we are starting from scratch today, assuming we max out our HSA every year for the next 20 years, do not withdraw funds, and with an 8% growth rate, we will have $391,000 in the future. Not too bad…
And then compound interest steps in to be really mean in this scenario…compound interest is the Chef’s Kiss when it comes to financial opportunity cost and missed opportunities.
Assuming we had invested in an HSA for the last 10 years, and we had that $101K as a starting point, if we continued to max out HSA contributions for the next 20 years, again assuming 8% growth, we would have had $856,273 for retirement. Meaning we will potentially miss out on $463,257 in investment growth.
Just a quick stipulation - I used very rough numbers, I didn’t project the growth of contribution limits, and did not discount the cost of having 2 kids and potential health expenses. Based on the history of contribution limit growth, we can only assume that the correct projection would be well over $1 Million assuming they maintain their current trajectory.
Don’t be us, research your health plan, and if a HDHP + HSA works for you based on your utilization, go for it! We missed out on having nearly $1 Million in retirement.
My Plan going Forward:
Max out our HSA contribution every year and invest in index funds
Ensure that we have 1.5 times the out-of-pocket maximum available to cover any emergencies. Until we grow the HSA to that level, we will rely on our existing emergency fund. We have focused on growing that far more than is generally recommended.
Invest the additional funds that we are saving by moving to the HDHP and are not being spent on our HMO premiums.
Summary:
Weighing the options between HSA and other alternatives is a daunting task, but I wish I had put in the time to research this earlier in my life. Healthcare costs are largely out of our control in this country and the best thing that we can do is set ourselves up now for future success.
The HSA is the best vehicle to use for future healthcare expenses for most people. If you are lucky enough to not have any major medical expenses before qualifying for Medicare, you may just get to withdraw your HSA funds tax-free as if it is a second 401K.
