Ch. 15:  HSAs

15.0 Introduction

            Health savings accounts (HSAs) are a real oddball in the financial planning domain.  But they freaking rule.  Contributions to an HSA reduce current-year federal income taxes, state income taxes, Social Security taxes, and Medicare taxes!  And, if you use the money in your HSA account to pay for medical expenses, you don’t pay any taxes on withdrawals.  Money goes in tax-free, is invested tax-free, and can be withdrawn tax-free. Thus, if used optimally, HSA accounts can be simultaneously traditional and Roth in nature. 

15.1 Basics of an HSA

            HSA accounts are often available to employees through employer-provided health insurance plans.  By contributing to an HSA account, one can avoid all four taxes (federal income, state income, Social Security, and Medicare).  Once an HSA account is open, the insured individual will receive a special HSA debit card in the mail.  That debit card can be used to directly spend money in the HSA to pay for covered medical expenses.  What is a covered medical expense?  Just about all valid medical costs, including typical vision and dental expenses.[1] If you’re unsure if an expense is eligible, you can use your HSA debit card to attempt to cover a transaction and your card will only be accepted if the expense is permitted.  Alternatively, you can pay for medical costs by any other method (e.g. cash or credit card) and then reimburse yourself manually later, usually by receiving a direct transfer from your HSA to a standard checking account.  If you use this method, you’ll need to be careful that you keep track of your transactions and keep receipts in the unlikely event of an audit.  Furthermore, if you self-reimburse, you’ll need to include a Form 8889 in your tax filing documents.  This form will likely be provided to you by your HSA provider with the information already filled-out.  Easy.

            Alternatively, you can access money in your HSA for any reason at age 65.  But, withdraws made for non-medical reasons are subject to federal and state income taxes.  But that’s still quite good!  Think about it.  Contributions to a traditional 401(k) avoid income taxes now, but you must pay income taxes upon withdrawal.  Comparatively, contributions to an HSA avoid income taxes and Social Security and Medicare taxes and you only need to pay income taxes if you withdraw after age 65 for a medical expense.  Thus, even at its worst, an HSA is superior to 401(k) plans and all other traditional tax shelters.  At the very worst, an HSA is 7.65% better than a traditional 401(k) from a tax standpoint.[2] 

            While your money is held in your HSA, it can be invested in the same types of funds that are typical of a 401(k) and similar plans—target date funds, mutual funds, index funds, etc.  There’s really no downside to an HSA.  For me, it is priority one in my list of desired tax shelters.  I make sure to max-out my HSA before entertaining contributions to any other tax shelters. 

15.2 Eligibility for an HSA

            To make contributions to an HSA plan, the investor must have a specific type of health insurance plan called a high deductible plan.  A high deductible plan is generally thought of as the “cheap” insurance plan.  Typically, one will purchase health insurance through an employer-provided health insurance firm.  But not all employers offer this perk, and not all employees will choose to use an employer-provided health insurance plan if their employer does.  Regardless, almost anyone earning income has the option to buy a high deductible health insurance plan and “unlock” access to an HSA account. 

            But many young folks will not have access to an HSA.  Parents have the option to keep their children on their health insurance plan until these kids reach age 26.  Based the structure of most health insurance plans, it’s usually inexpensive to do so and those in their 20s are wise to take advantage.  To be clear, if you are given the option to stay on your parents’ health insurance plan, do so!  At age 26, you will be abruptly cut off and you will be forced to navigate your health insurance elections on your own.  It’s a real pain in the ass, but the HSA should help relieve the pain if you, like most young folks, elect to use the high deductible plan. 

15.3 Contributions to an HSA

            Most elect to use the health insurance plan offered by their employer, which is typically cheaper than a private market plan.  In this case, your contributions to an HSA will happen via paycheck deductions, similar to 401(k) plans and other employer-provide tax sheltered plans.  But the parties involved will differ.  For a 401(k) plan, your contributions will likely be handled by your HR department or, less commonly, the investment vendor.  However, for an HSA, you’ll probably make contribution elections through your health insurance provider or associated vendor.  Ugh, it’s always so complicated. 

           Here is how my, very typical, HSA plan works.  I buy health insurance through a major provider named Optum.  On my Optum account page, I elect my contribution amount, which can be changed as often as I desire.  Because HSA contributions avoid all taxes, contributions are “cheap”.  For example, suppose your after-tax pay is typically $4,800/mo and you suddenly decide to contribute $300/mo to your HSA.  You might find that your after-tax income is now $4,600. How?  After all taxes are considered, perhaps your overall marginal tax rate is about 33.3%.  Thus, $300 in HSA contributions reduce your taxes by $100.  The same general logic applies to other traditional tax shelters, but the tax savings is greatest in an HSA since contributions to these accounts avoid Social Security and Medicare taxes. 

           Once my HSA money reaches Optum, I can open an investment account through HSABank.  Within HSABank, I can buy target date funds, index funds, and other assets (but never individual stocks).  I could go into more details, but every plan is so, so different.  Typically, your HSA will require you to hold some money in “cash”, which is really just a non-invested account within your HSA.  Any money beyond this $1,000 can be invested, but I must take action and choose investments or my money will all sit in a cash account.  When I make withdrawals from the account, the plan might automatically sweep money from the investment account into cash to revert back to a $1,000 cash holding.  Or, I might need to log into my account from time to time to manually move money into cash.  These features vary by plan so you will need to devote some time to learning how your account works.

          As with other tax shelters, there are strict HSA contribution limits.  In 2025, the limit for a single filer is $4,300.  For a person on a family plan, the maximum contribution is $8,550.[3]  Some employers offer a match on HSA contributions.  I’m in that group.  The University System of Georgia provides a $750 match for family plans.  Unfortunately, the match counts against the maximum contribution (unlike all other retirement plans we have discussed).  Thus, I contribute $7,800 to my plan, and my employer deposits $750 on my behalf.  It’s a good idea to ask about HSA matches when you are interviewing with companies and entertaining offers.  Employers are far more likely to promote retirement plans (like 401(k)s) than HSAs since the latter are only available to employees using one specific type of health insurance offering.

15.4 Spending Money in an HSA

          Say you go to the doctor’s office for a sinus infection and are told you owe the doctor’s office $200.  Without an HSA, most would use money from a checking account.[4]  This is tax inefficient.  Money in a checking account has already been earned; thus, it has paid all four taxes—federal income, state income, Social Security, and Medicare.  An HSA effectively makes all medical costs cheaper.  There are two ways to pay for medical expenses using an HSA.  And there is one way to (reasonably) access funds in an HSA without a medical expense.  Let’s look at each of these methods.

Method 1:  Withdraw for a Covered Medical Expense using an HSA debit card

• Members of an HSA will receive an HSA debit card soon after account opening.  You can use this card to pay for eligible medical expenses without much hassle.  If you use this method, there is no dire need to keep track or your expenses or save receipts.  This is the easiest way to spend money in an HSA.

Method 2:  Reimburse yourself for expenses

• This method allows the insured party to pay for medical expenses out of pocket and then reimburse yourself in the future.  If you choose this method, you will need to provide the aforementioned Form 8889 in your tax filing documents.  Why would anyone choose this method?  Well, for one, you might forget to take your HSA card to your healthcare provider and need to use an alternate payment method.  Or you might prefer to use a credit card to get cash-back or travel rewards.  There is no limit to how far back one can go, meaning that one can pay for a medical procedure in 2002 and reimburse themselves back in 2025.  But, you can only go back in time to the point where your HSA was open.  For me, I first opened my HSA in 2018, so I can reimburse myself for any covered medical expenses from 2018 to today.  Some exploit this loophole in creative ways[5], but I don’t trust my organizational skills.  I can’t keep track of receipts from decades past. 

Method 3:  Withdraw after 65

• If you’re an aggressive saver, it’s feasible that your HSA account balance could grow to the point that your HSA value is larger than your lifetime expected medical expenses.  In this unlikely scenario, you can choose to withdraw money from your HSA penalty-free.  To do so, you must be at least age 65.  A non-medical withdrawal will trigger income taxes (but not Social Security or Medicare taxes) in the same fashion as a withdrawal from a traditional 401(k) or similar account.  Is it likely you will do this?  No.  As you get older, your medical costs will rise and there are many medical costs near the end of one’s life.[6]  Instead, if you need cash, you should totally exhaust all your other accounts first.  For example, if you have $100,000 in a 401(k) and $60,000 in an HSA, the 401(k) should be totally depleted before you consider making non-medical withdrawals from the HSA.  Keep the HSA funds in-tact so that they may be used for medical costs if necessary.  Personally, I will never make a non-medical withdrawal from my HSA.  When I die, I will likely still have money in my HSA, which can be easily passed-on to my inheritors.[7]  Regardless, the fact that you can withdraw money from your HSA is great news. It means that there is no such thing as having “too much” money in your HSA as some erroneously fear.

           Regardless of which method you use, make sure that you remember that an HSA works best when it is used to cover medical expenses (even if it takes you years to reimburse a given expense).  A couple of year’s back, I had an older client with about $100,000 in her HSA.  She had never spent a dime in her account because she wanted to make sure she had plenty of money in her HSA to cover medical expenses later in life.  I appreciate the sentiment, but she is failing to play the game correctly.  By using an HSA to cover your medical expenses, you are effectively able to earn income completely tax free.  There is literally no way to improve beyond totally tax-free money.  So, don’t be shy… spend the money in your HSA (on medical costs)![8]

15.5 Optimal Use

         Maybe this is redundant, but let’s make sure we understand how to use an HSA from contribution to withdrawal.  Follow these steps and build your wealth. 

1. Choose a high deductible plan at age 26 (or as early as possible). 

• Well… you might prefer a different plan, but this is the only health insurance plan that allows for HSA contributions.  So this has to be step 1.

2. Max-out your HSA contribution each year.

3. Invest as much as permitted by your plan. 

• Choose low-cost investment(s) that fit your risk profile—for a young person, this probably means a total stock market index fund or target date fund.

4. Use your HSA to cover all eligible medical costs throughout your life.

5. Die (this step is unavoidable). 

• Any remaining HSA money will be included in your estate—the money given to your inheritors.  The taxes on transfer may be complicated but I wouldn’t worry about this; let your attorney and inheritors figure this out.

That’s it.  It’s simple.  If you can start contributing at an early age and do so consistently, it’s likely your account will reach six-figures by retirement age.  I encourage you to view HSA contributions as non-negotiable.  Don’t make contributions an option, make them feel mandatory. 

***Disclaimer***

            However, I will note that there are rare cases in which an HSA is not so great.  Some HSA vendors have no low-cost investment funds.  If every investment option levies an expense ratio in excess of, say, 1%, an HSA may not be priority 1 for saving.  Even worse, some HSA accounts don’t allow investments at all!  In either case, I would still use an HSA  The tax savings of an HSA are still useful, but the poor or non-existent investing options make the account less useful.  If I had an HSA account with very crappy or non-existent investment options I would first complain to anyone that would listen.  If I voice my concern, I might be able to convince my HR department, HSA bank, or vendor to offer better options.  If my whining and moaning is unsuccessful, I would still use the HSA, but I’d alter my strategy.  Once my HSA reached about $10,000 in value, I would likely divert additional funding to other tax shelters.  These types of nuanced decisions are difficult and require an understanding of taxes, other tax-sheltered plans available, and one’s future goals. 

15.5 Conclusions

            When I first joined my university back in 2016, the HR department held a benefits workshop for all new employees.  I was the most financially savvy new hire in the room simply because I had already spent three years as a professor within the state of Georgia’s benefit system so I knew the program fairly well.  About an hour into the workshop, the HR representative mentioned the HSA as a good way to save money for medical expenses.  I raised my hand and told everyone in the room about the HSA—how it avoided all four taxes, how the money could be used on medical expenses tax free, and the nice feature that HSAs can be invested. 

           The HR presenter stopped me and told the room, “I agree that HSA accounts are really nice, but you cannot invest your HSA.”  I pushed back, stating that I was pretty sure you could and that it was the only health insurance account that allowed investing.  The HR presenter dug-in, “I wish, but no… your HSA cannot be invested.”  Finally, I pulled out my laptop and showed my invested HSA to everyone in the room.  The HR representative didn’t say a word.  Three years later, my wife joined my university and sat through the same HR presentation and AGAIN the HR presenter (same person) told everyone in the room that the HSA cannot be invested and that my wife (I trained her well) was wrong.  People are so bad at personal finance and even the most ignorant are quick to provide crappy advice.

           Spread the gospel of HSAs.  Prepare for others to misunderstand the benefits and be quick to step-in and guide them.  Expect your friends to have five-figures of money uninvested in their HSA account; help them learn how to invest.  Do some good.

Key Terms

Health Savings Account:  Reach the chapter, you bum

High Deductible Plan:  Health insurance plan that has low monthly costs (premiums) and a high deductible.  Only those with a high deductible plan can make contributions to an HSA.

End Notes

[1] See a list of eligible medical expenses here.

[2] Where did I get 7.65%?  Social Security taxes is 6.2% and Medicare is 1.45%.  By contributing to an HSA, you avoid these two taxes.  Contributions to other traditional tax shelters do not.

[3] The maximum contribution for a married couple is $8,550.  So, under the rare circumstance that I have a family plan and my wife has a separate health insurance plan, we cannot exceed $8,550 in combined contributions. 

[4] Even if you use a credit card, the credit card bill is paid with a checking account.

[5] For example, suppose you had $40,000 in medical expenses from 2005 to 2025 that you paid via credit card or cash.  At any point, you could redeem up to $40,000 tax free by reimbursing any or all of these old expenses.  It’s like you’ve unlocked a tax optimized emergency fund!

[6] HSAs can be used to cover nursing home costs, in-home care, hospice care, etc. 

[7] The taxes on the transfer to beneficiaries is pretty complicated and not especially tax-friendly.  In my opinion, this should not affect your decision-making process.  The benefits of an HSA are so great that this small downside is miniscule in comparison.

[8] I advised her to always spend money in her HSA account when she had an eligible medical expense.  In doing so, she would then have extra unused income (the post-tax income that she would have spent on the medical care out of pocket).  I advised her to take that extra income to make Roth IRA contributions.  She ignored my advice and continued to “save” her HSA.  

 Practice Problems

1. Alex is 33 years old and single.  He earns $72,000 from his job as a real estate agent.  In 2025, he contributes $3,000 to his HSA account.  Assume that his health insurance plan is offered by his employer.  Solve for his…

a.     Federal Income Taxes

Taxable Income = $72,000 - $3,000 = $69,000

Income Taxes = $10,094

b.     Social Security Taxes

SS Income = $69,000

SS Taxes = $4,278

c.      Medicare Taxes

Medicare Income = $69,000

Medicare Taxes = $1,000.50

2. Jason is 33 years old and single.  He earns $72,000 from his job as a real estate agent.  In 2025, he contributes $3,000 to his HSA account.  Assume that his health insurance plan is not offered by his employer; rather, he pays for his health insurance through a private firm.  Solve for his…

a.     Federal Income Taxes

Taxable Income = $72,000 - $3,000 = $69,000

Income Taxes = $10,094

b.     Social Security Taxes

SS Income = $72,000

SS Taxes = $4,464

c.      Medicare Taxes

Medicare Income = $72,000

Medicare Taxes = $1,044

3. Regarding Jason’s situation from question 2… when will he effectively realize the income tax break that he gets from his HSA contribution?

Since it’s not connected to employment, he will not get the income tax break until he files his return.  And, to be clear, he will never get the tax break for his Social Security and Medicare contributions; when you use a non-employer sponsored health insurance plan, HSA contributions do not impact Social Security and Medicare taxes.

4. Brandi is single and earns $110,000 at her job.  She contributes $6,000 to a traditional 401(k) and $2,500 to an HSA (through an employer-provided health insurance plan).  Solve for her…

a.     Federal Income Taxes

Taxable Income = $110,000 - $6,000 - $2,500 = $101,500

Income Taxes = $17,244

b.     Social Security Taxes

SS Income = $110,000 - $2,500 = $107,500

SS Taxes = $6,665.00

c.      Medicare Taxes

Medicare Income = $110,000 - $2,500 = $107,500

Medicare Taxes = $1,558.75

5. A married couple earns a combined $164,000 from their jobs.  In 2025, they max-out their HSA (family insurance plan purchased through their employer), which does not offer an employer match.  They contribute $10,000 to traditional 401(k) accounts and both max-out their Roth IRA accounts. In a taxable account, they earn $3,000 in qualified dividends.  In the same taxable account, they sell shares of stock for $14,000 that they bought for $6,000 9 months ago.  Solve for their…

a.     Federal Income Taxes

Taxable Income = $164,000 - $8,550 - $10,000 + $8,000 = $153,450

Income Taxes = $23,587

b.     Social Security Taxes

SS Income = $164,000 -$8,550 = $155,450

SS Taxes = $9,637.90

c.      Medicare Taxes

Medicare Income = $164,000 -$8,550 = $155,450

Medicare Taxes = $2,254.03

d.     Capital Gains Taxes

Capital Gains = $3,000 (they are in the 15% bracket)

Capital Gains Taxes = $450

6. You are 23 years-old and just graduated from college.  Explain why it is might be financially sound to not contribute to an HSA.

It would be best to stay on your parents’ health insurance plan if this is an option for you.  If this is the case, you will not have your own health insurance plan in your name and will not have the option to contribute to an HSA.

7. Grant has $10,000 in his checking account and $5,000 in his HSA account.  He has a $700 medical cost that he needs to pay today.  He’s planning to use the money in his checking account so that he can allow the money in his HSA to stay invested.  Is this smart?

No, unless he plans to reimburse himself back for this expense in the future.  The greatest value from an HSA is realized when a person is able to pay for medical costs with their HSA account.  When this occurs, the person has effectively earned, invested, and spent money without ever paying income, SS, or Medicare taxes.  So he should use his HSA.  But there is no rush in doing so as long as he can keep track of his receipts.

8. True story… my brother-in-law works for a company that gives him $2,000 to his HSA account each year.  This isn’t a match per say since he doesn’t have to contribute anything to get the $2,000.  In 2025, how much can my brother contribute to his HSA?  He is on a single health insurance plan.

The $2,000 counts against his limit unfortunately.  So, he can only contribute $2,300 himself.

9. Compared to other investment vehicles, what is so special about an HSA?

Basically two things.  One—contributions to an HSA, if made through an employer-provided plan, allow the contributor to reduce SS and Medicare taxes in addition to income taxes.  Two—If you use HSA funds to pay for a medical expense, you have effectively avoided taxes entirely.  Comparatively, other traditional contributions (like 401(k) plans) only avoid income taxes and you must pay income taxes upon withdrawal.

10. A 70-year old withdraws $20,000 from an HSA account to use on a vacation.  How will this be taxed/penalized?

They will need to pay income taxes on the full $20,000.

11. A 50-year old withdraws $20,000 from an HSA account to use on a vacation.  How will this be taxed/penalized?

Yeah, don’t do this.  This person will be forced to pay a penalty and income taxes on the full $20,000.  I don’t care if you know the specifics of this rule, just DON’T DO THIS.

12. I withdraw $8,500 from my HSA as a reimbursement for old health insurance costs.  What must I do when I file my taxes?

I need to fill-out a Form 8889 to note this withdrawal on my taxes.  If I don’t, the IRS may assume that I made a non-medical withdrawal and I’ll get a notice in the mail asking for extra taxes to be paid.

13. Mary is deciding whether to contribute $2,000 to an HSA or a traditional 401(k).  She already has $300,000 in her HSA so she really doesn’t need more money to cover medical expenses.  Which would you recommend?

HSA.  Contributions to an HSA avoid income taxes, SS taxes, and Medicare taxes.  401(k) contributions only avoid income taxes.  Once she reaches 65, she can fully withdraw from her HSA without reimbursing for medical expenses.  If she does so, she will only pay income taxes.  Since HSA contributions avoid SS and Medicare taxes in addition to income taxes, the HSA is a better choice unless she really needs to withdraw money between age 59.5 and 65.