Summary

• Potential Tax Advantages: Contributions are made with pre-tax dollars, grow tax-deferred, and withdrawals for qualified medical expenses are tax-free, making HSAs triple-tax advantaged.

• Long-Term Growth Potential: Investing HSA contributions in growth-oriented investments can potentially increase the funds available for future health care costs, helping to meet the rising cost of medical care.

• Eligibility and Considerations: To qualify for an HSA, one must be covered under a high deductible health plan (HDHP) and meet other specific criteria. It’s important to weigh the higher out-of-pocket costs against the long-term benefits.

According to the U.S. Census Bureau, about 54% of Americans were covered by employment-based insurance in 2022.

If you are in that group, that means each Fall, you have a choice. Participate in a high deductible health plan (HDHP) and contribute to a Health Savings Account (HSA) or go another route.

Before covering some of the potential benefits of HSAs, they are not a one-size-fits-all solution. There are some downsides to consider. For example, current out-of-pocket costs will likely be higher by choosing a high deductible plan. The most obvious reason is in the name – higher deductibles that come with high deductible plans. Additionally, to realize the biggest long-term benefits, HSA contributions should remain invested within the HSA for as long as possible to take advantage of potential market growth. That means paying more current health care costs out-of-pocket, not from the HSA. For families who expect to have significant medical bills, those costs can add up. It is important to consider personal circumstances when choosing health coverage options. If you have questions, consulting your Human Resources partners or other trusted professionals can help.

For those who think an HSA might still be a good fit, you must meet these requirements:

• Be covered under a high deductible health plan

• Have no other health coverage

• Not be enrolled in Medicare

• You cannot be claimed as a dependent by someone else

If you check those boxes, here are some reasons you may want to give the HSA serious consideration.

Inflation

The cost of health care continues to rise. A recent Barron’s article pointed to research that suggests the cost of health care for a 65-year old retiring today could be $165,000.

That’s a serious number. On top of that, health care costs have historically risen faster than prices of other items.

Chart 1 compares the rising cost of medical care (the green line) to all items (the orange area). Since 1980, medical care costs have risen nearly 700%, or about 4.8% per year. The Consumer Price Index for all items is up just over 300%, or 3.2% per year, over that same time.

I am 43 years old. If the estimated medical care costs I mentioned above rise by 4% per year, by the time I’m 65, the cost of my future health care could be a whopping $391,000.

Having a pool of money like an HSA earmarked to help cover those costs seems pretty attractive.

Growth

If those health care inflation numbers sound scary, the HSA can help.

Individuals can contribute $4,150 to an HSA in 2024. Families can contribute $8,300. And those who are at least 55 years old can contribute an additional $1,000. These contribution limits typically rise with inflation as well.

One of the biggest missed opportunities related to HSA funds is that investors often leave their contributions invested in cash. We see this all the time.

The default landing spot for HSA contributions is usually cash. Left alone, inflation will slowly eat away at those contributions.

Most HSAs provide a menu of investment options. Choosing to invest those HSA dollars in growth-oriented investments can potentially have a big impact of paying for health care needs down the road.

I will use myself as an example again, using some conservative assumptions.

Assume the HSA contribution limit remains unchanged for the next 22 years and I contribute $4,150 per year until age 55, then the contribution rises to $5,150 to take advantage of the catch-up contribution. By the time I’m 65 years old, as long as I have not spent that money along the way, my total contributions would have been $102,300.

Chart 2 shows the potential impact of investing those annual HSA contributions compared to letting them sit in cash, earning nothing. The brown bars represent the annual contribution, including the $1,000 catch up contribution beginning at age 55. The green bars show the cumulative contributions over time. And the orange line assumes those contributions are invested, earning 7% per year. These are hypothetical results and individual investment performance will vary.

Earlier this year, we wrote a post called, “How to Beat Inflation.” We argued that investing for the long-term is one of the best ways to protect and improve our quality of life. Health is a big part of that.

Taxes

The HSA is full of tax benefits.

1. Contributions are made with pre-tax dollars. Assume a family is in a combined marginal tax bracket – federal and state – of 30%. They can save $2,490 in current-year income tax by contributing the maximum $8,300 to an HSA. The higher your tax bracket, the bigger the current year tax advantage.

2. HSA assets grow tax-deferred. No need to worry about the tax consequences of interest, dividends, or capital gains on investments held in those HSAs. All of it grows tax-deferred.

3. Withdrawals for qualified medical expenses are tax-free. IRS publication 502 outlines which expenses qualify. It is a long list, starting on page 5.

The combination of these three tax benefits – pre-tax contributions, tax-deferred growth, and tax-free withdrawals – are why we say the HSA is triple-tax advantaged, and why the account is so unique. Traditional IRAs can’t compete – the withdrawals are considered ordinary income. Roth IRAs can offer tax-free distributions, but the contributions are made with after-tax dollars.

Thinking Long-Term

At the beginning of this post, we highlighted the estimated cost of health care for a 65-year-old, as well as the rising cost of health care. To help understand the long-term tax benefits of HSAs, consider the numbers in Table 1.

The table assumes the expected future health care costs for a 65-year-old in 2024 are $165,000, and those costs will rise by 4% per year.

The green boxes project what those health care costs will be 10, 20, and 30 years from now.

And the white boxes under the tax rate headers estimate the pre-tax assets needed, at varying tax rates, to cover those future expenses.

For example, a 45-year-old individual would look at the “20 years” row, since they are 20 years away from age 65. The estimated future cost of health care, beginning at age 65, is $361,535. And if they expect to be in the 25% tax bracket, they would need about $482,047 in pre-tax assets to fund those expected health care expenses.

Costs may change over time. The bulk of those health care expenses are likely to come in later years, and the assets may grow faster than health care inflation. The point of this example is not precision. We wanted to illustrate, at a simple and high level, how the long-term tax and investment benefits of an HSA can be so compelling. Hopefully that much is clear.

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