A Guide to Invest with Your HSA

Health savings accounts (HSAs) are becoming an increasingly popular tool for saving toward future medical expenses and even boosting retirement funds. In 2023, nearly one-third of insured workers were enrolled in health plans with a savings option, a significant increase from 17 percent in 2011, according to the Kaiser Family Foundation. HSAs offer numerous benefits, including the ability to invest and grow your savings tax-free.

Here are some tips for investing your HSA and key details about these growing savings vehicles.

What is an HSA and how do the tax breaks work?

An HSA, or health savings account, is available to individuals with a high-deductible health plan (HDHP) and helps cover out-of-pocket medical expenses. For 2024, the minimum deductible for an HDHP is set at $1,600 for individuals and $3,200 for families.

HSAs offer a triple tax advantage, making them an appealing savings tool:

• Contributions are tax-deductible, with a limit of $4,150 for individuals and $8,300 for families in 2024. Individuals aged 55 and older can contribute an additional $1,000 as a catch-up contribution.
• Earnings on the account grow tax-free as long as funds are used for qualified medical expenses like deductibles, copayments, and other healthcare costs.
• Withdrawals for qualified medical expenses are tax-free. Unused funds roll over year to year, allowing you to save without a deadline for spending.

If you use HSA funds for non-qualified expenses, a 20 percent penalty and income taxes apply. However, after age 65, the penalty disappears, and you can withdraw funds for any purpose, though income taxes will apply to non-medical expenses. You can still make tax-free withdrawals for qualified medical costs.

Because of these benefits, many people treat their HSA as an additional retirement savings account, similar to an IRA or 401(k), a strategy favored by many financial advisors.

Best ways to invest an HSA

Although investing HSA funds is one of the best ways to maximize the account’s benefits, surprisingly few people take advantage of it. In 2022, only 13 percent of HSAs were invested, according to the Employee Benefits Research Institute. One reason for the low participation could be the high minimum balance requirements some HSA providers set for investing (usually around $2,000). However, once you’ve met that threshold, it’s worth exploring investment options.

How you invest your HSA will depend on your personal financial situation. Assessing your risk tolerance and anticipated medical expenses will help guide your investment choices. For instance, if you plan to use your HSA primarily for retirement, you may want to opt for higher-return investments. Here are a few potential options:

Money market funds

If you maintain a modest HSA balance or plan to access the account regularly, low-risk options like money market funds might be a good choice. They offer stability, ensuring the funds will be available when you need them for medical expenses.

However, it may make sense to keep only the money you’ll need in the near future in money market funds, while investing longer-term funds in higher-risk, higher-return assets. This strategy can provide better long-term growth potential, but keep in mind that it also comes with more risk.

Stocks and funds

For those who anticipate minimal medical expenses in the coming years, investing in stocks can be an excellent way to grow your HSA. Stocks tend to offer strong long-term returns, but they can be volatile, so it’s important to balance risk. If you’re relying on the HSA for upcoming medical expenses, keep a portion in cash or money market funds to cover those costs. Here are some stock options:

• Index Funds: These funds track a broad market index, like the S&P 500, providing diversification at a low cost. Index funds are available as mutual funds or ETFs and come with low fees, meaning more of your returns go directly to you.
• Dividend Funds: Funds that focus on dividend-paying stocks can offer regular income and tend to be less volatile than growth stocks. Dividends in an HSA can be reinvested tax-free, helping to grow your account over time.
• Individual Stocks: Investing in individual stocks carries the most risk but also the potential for outsized returns. However, a lack of diversification can lead to significant losses if the stocks don’t perform as expected. Be sure to thoroughly research any company before investing.

Fixed income

If you’re more risk-averse or expect to need funds for medical expenses soon, consider fixed-income investments like short-term bond funds. These tend to offer lower returns but provide stability, helping to preserve your capital while generating some income.

Robo-advisor

If you prefer not to pick investments yourself, some HSA providers offer robo-advisor services. These automated tools create a diversified investment portfolio based on your risk tolerance and financial goals. Robo-advisors typically charge lower fees than traditional advisors. For example, Fidelity Go offers HSA management with no management fees for balances under $25,000 and just 0.35 percent for accounts over that amount.

While it’s tempting to treat your HSA as a retirement fund, this strategy only works if you can cover medical expenses with other savings. You want to ensure that your HSA is available for healthcare needs, so make investment decisions carefully to avoid potential shortfalls.

What happens to HSA funds after retirement?

Once you turn 65, you can withdraw money from your HSA for any purpose. However, if the funds are used for non-qualified expenses, they will be subject to ordinary income taxes. Prior to age 65, withdrawals for non-qualified expenses also incur a 20 percent penalty on top of being taxed as ordinary income, so it’s best to avoid these early withdrawals.

You can continue contributing to your HSA as long as you’re covered by an HSA-compatible health plan and have not enrolled in Medicare. Most people enroll in Medicare at age 65, which means HSA contributions typically stop at that point. However, the money in the account can still be used, similar to a 401(k) or IRA. While you can no longer make new contributions if you’re on Medicare, you can continue to use your HSA for qualified medical expenses and enjoy tax-free withdrawals.

In Conclusion

To fully maximize the benefits of an HSA, it’s essential to take advantage of its investment opportunities. For those with a longer time horizon, stocks are likely the best option for growing your account’s value. However, if you prefer a more cautious approach or anticipate medical expenses in the near future, sticking with short-term fixed-income investments is a safer choice.