Personal Finance | September 6, 2022

Is an HSA a Good Deal?

Dear Carrie,

I'm starting my first job and wondering about the HSA option that comes with my benefits package. I’m healthy and hardly ever need to see a doctor. Is this a good deal?

—A Reader

Dear Reader,

The short answer to your questions is "yes," a health savings account (HSA) can be a very good deal. This is especially true for someone like you just starting out. The combination of tax advantages and a long time horizon is ideal for making the most of this particular benefit, not only to handle potential medical expenses but also to help build long-term financial security. Here's why.

The nuts and bolts

An HSA is a tax-advantaged account available to those who have a qualifying high-deductible health plan (HDHP). In 2022, that's a plan with deductibles of at least $1,400 for an individual, or $2,800 for a family. One benefit of an HDHP is that monthly premiums are comparatively low.

For a young person with few medical expenses, that can be a pretty good deal right there (provided you can cover the higher deductible). But there's more. Similar to an IRA, an HSA lets you make annual contributions and offers significant tax perks. And that's where the good deal really starts.

There's a triple tax advantage

One tax advantage is good. Three are better.

  • First, contributions to an HSA are federally tax-deductible, reducing your taxable income. Depending on where you live, you may also get a break on state income taxes.
  • Second, both contributions and earnings grow federal tax-free.
  • Third, withdrawals for qualified out-of-pocket medical expenses are also tax free—whenever you take them, no matter your age. Those expenses can include deductibles, copayments, prescriptions, and necessary medical equipment as well as medical care not covered by insurance such as dental, vision, hearing, and long-term care. You can also use it to pay for medical expenses for a spouse or other dependent.

If you take the money for something other than a qualified medical expense, it's a different story. In that case, you'd pay ordinary income taxes on the withdrawal and a penalty if you're under age 65. (Starting at age 65, HSA withdrawals for non-medical expenses are penalty-free but subject to ordinary income tax.) Clearly, if you follow the rules, the tax benefit can be significant.

It rolls over year after year

A particularly positive feature of an HSA is that if you don't use it, you don't lose it (unlike a flexible savings account, or FSA). So there's no pressure to spend for the sake of spending. If you don't need to use it, just let that money grow tax-free. Plus, an HSA is portable. If you change employers, you can take it with you. 

You're eligible regardless of your income

Unlike deductible IRAs or Roth IRAs, there are no income limits associated with an HSA. This means that higher wage earners can take 100% advantage of a federally tax-deductible account unlike others they may not qualify for. In this way, an HSA can act as a supplemental IRA.

You can put it to work for your future

An HSA isn't just a savings account; it can also be an investment account. So if you're fortunate enough not to need the money to cover ongoing medical costs, you may be able to invest the balance in mutual funds, ETFs, stocks or fixed income (depending on what the plan offers, and typically once a minimum account balance is reached).

Time is, of course, a key factor in taking full advantage of the investment growth potential of an HSA. And at your age, time is one of your greatest assets. Put it to work now and your HSA could be a supplement to your retirement accounts or maybe even act as a retirement account just for healthcare when you reach those golden—yet often costly—years.

The catch: You have to fund it

Of course, all these benefits only work if you actually fund your HSA and that means making contributions, ideally up to the max allowed. For 2022, annual contribution limits are $3,650 for an individual, $7,300 for a family. Plus, there's an extra $1,000 annual catch-up contribution for those 55 and over.

Since your employer offers an HSA as a benefit, you may be able to have your contributions automatically deducted from your paycheck. And if you're lucky, your employer may also offer contributions. Just be aware that total contributions can't exceed the annual limit. Check with your benefits provider.

If you're on your own in making contributions, you may be able to set up an automatic monthly deduction from your bank account, or simply write a check to the HSA account. But however you make the payments—make them consistently. You don't have to contribute the max, but if you can, it's a great way to increase your savings.

Here's an example that may convince you. Let's say you contribute the current individual maximum of $3,650 per year for 35 years. That may sound like a lot, but it's actually about $304 per month pre-tax. Let's also say that you withdraw an average of $1,000 a year in medical expenses. If you earned an annual average of 5 percent on the balance of your HSA, you'd end up with about $250,000.

A couple more things to think about

To me, the pluses generally far outweigh the minuses. But as always, do your homework to make sure an HSA is the right choice for you. First get the details on any high-deductible plan, especially possible medical network requirements or restrictions.

And while the upfront tax advantage of an HSA is great, an HDHP means you'll have a higher deductible to cover. That could mean higher initial out-of-pocket healthcare expenses (however, most HDHPs provide preventative services like routine checkups, prenatal and well-child care, immunizations, and certain screening services before having to meet the annual deductible). But the idea is that reduced premiums plus HSA tax advantages will compensate.

You'll also want to check for potential HSA fees such as monthly maintenance as well as costs related to checks or debit cards. Also be aware of investing costs if you invest your HSA in mutual funds or other securities. Be sure to get the details from your employer or the financial institution providing the HSA. 

That said, I'd definitely consider taking advantage of this benefit even if you start with a small contribution. It can be a win in terms of medical needs, taxes—and your long-term financial health. Sounds like a good deal to me.

Have a personal finance question? Email us at Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.