Here’s the best way to use a health savings account, which offers a triple-tax advantage

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Health savings accounts can be a powerful way to build wealth and prepare for medical costs in old age — if they’re used the right way.

HSAs carry a three-pronged tax benefit. Contributions and investment growth are tax-free, as are withdrawals if used for qualified health expenses.

Even if a withdrawal isn’t health-related, the account owner would only owe income tax on those funds — in effect turning the HSA into an account with tax benefits akin to a traditional 401(k) plan or individual retirement account.

“I almost don’t think of them as health savings accounts, but profoundly tax-beneficial retirement accounts,” said Andy Baxley, a Chicago-based certified financial planner at The Planning Center.

Ideal use

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The ideal way for savers to use HSAs is by contributing the annual maximum, investing the money and paying for present-day health costs out of pocket via other savings, according to financial advisors.

This allows time for HSA money to grow tax-free. HSA investments are like those in any other retirement account, with diversified stock and bond mutual funds, for example.

Most people don’t invest their HSA savings, however. They instead use HSAs like a bank account and withdraw cash as needed to pay for current medical costs.

Just 9% of accountholders were investing a portion of their HSA balance in 2020, according to the Employee Benefit Research Institute. The remainder — 91% — held their full balance in cash.

But this offers virtually no upside growth — a disadvantage when health costs in retirement are expected to be about $300,000 for the average couple who retired in 2021, according to a Fidelity Investments estimate.

The IRS outlines a wide variety of qualifying HSA health costs, like those associated with dental care, vision, hearing, long-term care insurance premiums (subject to limits) and medicines, for example.

HSA reimbursement

Savers who pay out of pocket now for health costs can take advantage of another HSA benefit in future years: They can withdraw account funds to pay themselves back (tax-free) for those earlier expenses.

As with withdrawals from a Roth 401(k) or IRA, these HSA reimbursements can offer retirement income and help someone control their tax bill.

An HSA is a no-brainer for almost everyone who has access to one.
Carolyn McClanahan
founder and head of financial planning at Life Planning Partners

Say you’re on the cusp of jumping into a higher income-tax bracket in retirement but had spent $10,000 out of pocket over the years on medical bills. You can withdraw that $10,000 from your HSA for past costs without raising your taxable income.

(One important point: Expenses incurred before you establish your HSA aren’t considered qualifying medical costs.)

“I think [people] often don’t realize just how broad the list of things you can be reimbursed for is,” Baxley said, citing fertility treatment as an example.

He recommends creating a spreadsheet of unreimbursed medical expenses (to know how much you can pay yourself later) and keeping receipts for proof.


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Of course, many people don’t have the financial means to use HSAs in the ideal way.

Individuals are living longer and have had to adopt more individual responsibility for their retirement savings, as companies have switched pensions for 401(k) plans, for example.

Limited cash flow may mean having competing financial priorities: emergency funds, retirement plans and health savings, for example. (Individuals and families can contribute up to $3,650 and $7,300, respectively, to an HSA this year.) Paying out of pocket for current costs may also not be possible, depending on a person’s financial situation.

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Further, only those with high-deductible health plans can save in an HSA. In 2021, 28% of workers covered by employer-sponsored health insurance were enrolled in a high-deductible health plan with a savings option like an HSA, according to the Kaiser Family Foundation. (Enrollment is a bit higher in large firms with more than 200 workers.)

Caveats aside, those with access should try using them as optimally as possible, financial advisors said.

“An HSA is a no-brainer for almost everyone who has access to one,” according to Carolyn McClanahan, a medical doctor and CFP who is founder and head of financial planning at Life Planning Partners in Jacksonville, Florida.

A high-deductible plan — and, by extension, an HSA — might not be the best choice for everyone. For example, someone with a chronic illness that leads to frequent doctor visits may get a bigger financial benefit from a plan with lower annual out-of-pocket costs.

How to invest

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Like any other investment account, it’s imperative to understand your financial and psychological ability to take risk by investing your HSA funds, McClanahan said.

That means being able to withstand the ups and downs in the stock market, and aligning your strategy to your investment time horizon.

A young saver with the financial wherewithal to pay out of pocket for present-day health costs can afford to take risk, for example — perhaps in a low-cost broadly diversified stock fund, McClanahan said.

However, savers who don’t have the means to cover their annual deductible or out-of-pocket maximum with other savings should keep at least this amount in cash or something else conservative like a money-market fund before investing the rest, McClanahan said. (Some HSA providers require accountholders to keep a certain amount in cash before investing.)

This is especially the case for savers who aren’t healthy and need frequent health care, she added.

Similarly, someone closer to retirement age should likely reduce their stock allocations to avoid putting money at risk near the age at which they’ll start tapping their accounts.

Sophie Tremblay

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