Investing an HSA
A health savings account allows a deduction on the way in, growth that is not taxed inside it, and withdrawals that are not taxed when spent on qualified medical expenses. Most balances sit in cash by default, which forfeits the middle advantage entirely and leaves the account working as a spending account.
Most tax wrappers make one concession. This one makes three, and the reason it is so often wasted is that it arrives looking like a bank account and gets treated as one.
How it works
Contributions are generally deductible, growth inside is not taxed, and withdrawals for qualified medical expenses are not taxed either. That combination is unusual.
Most providers default the balance to a cash account. Investing generally requires an explicit choice, sometimes above a minimum balance, and most people never make it.
Cash cannot grow, so the tax-free growth benefit applies to nothing. The account still works as a spending account with a deduction attached, and the largest of its three advantages is inert.
A worked example
Take $4,000 contributed a year for twenty-five years.
Held in cash it is 100,000, plus whatever interest a cash account paid.
Invested at an assumed 7% it reaches 252,996.
The 152,996 difference is the growth advantage the account exists to provide, and the only thing that separates the two is a setting.
Eligibility and rules
Contributing requires being covered by a qualifying high-deductible health plan. Eligibility is assessed on the plan rather than on income, which is unusual among tax-advantaged accounts.
Stay under the annual limit. Money paid in above it is an excess contribution, and the IRS generally charges a 6% excise tax on it for each tax year it stays in the account. Withdrawing the excess, and what it earned, by your return’s due date including extensions avoids the tax.
You can keep and invest an existing balance after eligibility ends — you simply cannot add to it, which is why an account opened during one job continues working long afterwards.
Non-qualified withdrawals are taxed and usually penalized before a certain age, and after it are generally taxed as ordinary income. The rules are statutory and revised; this is educational, not tax advice.
Paying now against reimbursing later
In several systems a qualified expense can be reimbursed at any point afterwards, so paying a medical bill from other money and keeping the receipt leaves the balance invested and creates a tax-free withdrawal available whenever you want it.
That turns the account into a long-horizon investment with an escape hatch attached, which is the strategy the account’s structure most rewards.
It requires keeping records for decades, which is the practical constraint and the reason most people do not do it.
Costs
Provider fees vary enormously — monthly account fees, investment platform fees and fund fees can all stack. Charges of 0.75% a year cost 20.2% of the ending balance over thirty years, and 1.5% costs 36.5%.
An employer-provided account can generally be transferred to a cheaper provider while contributions continue through payroll, which is worth checking once and rarely is.
How to set it up once
Check whether the provider requires a minimum cash balance before investing. Many do, and that figure is the amount that will never be invested no matter what else you decide.
Then decide the cash portion deliberately. One or two years of the plan’s deductible is a defensible figure; anything beyond that has a long horizon and belongs invested.
Pick the cheapest broad fund the platform offers. The account is small relative to a retirement balance, so a monthly account fee plus an expensive fund is a large percentage of it — and the same 20.2% thirty-year figure applies here as anywhere.
And set the contribution to happen through payroll where that option exists. In several systems that avoids payroll taxes as well as income tax, which is a fourth advantage the account is rarely credited with.
Then leave it alone. The account has no ongoing decisions once the cash portion and the fund are set, and the whole value of the arrangement comes from the years during which nothing is done to it.
The original data
Of the 24,971 unique videos collected for this site’s search study, 2 have a title about health savings accounts, at a median of 133,454 views across 2 channels — and 50% of those titles are instruction-shaped. Roth accounts appear in 24 videos at 95,293 and workplace plans in 22 at 81,626.
Two videos at a 133,454 median — a higher figure than the twenty-four covering Roth accounts. The account with the strongest tax treatment available has almost no instructional coverage, and what exists reaches a large audience.
The question: Medical costs could arrive any year. Keep it in cash?
The answer is that a portion should be, and rarely the whole balance. Holding one or two years of the plan’s deductible in cash covers the realistic near-term call on it; the rest has a horizon measured in decades. Treating the entire balance as an emergency fund is what produces the cash default — and the deductible is a knowable number rather than a feeling.
When it fails
The failure is an account used exactly as intended and never invested. Contributions go in, the deduction is claimed, medical costs are paid straight out of it, and the balance hovers near zero for twenty years. Nothing went wrong and the account delivered one of its three advantages. The other two required a decision that the interface never asked for, and the cost of not making it does not appear anywhere.
The second failure is a high-fee provider. On a small balance a monthly fee is a large percentage.
A third is not keeping receipts. They are the mechanism that makes later reimbursement possible.
A fourth is contributing while ineligible. Eligibility depends on the health plan.
A fifth is treating the whole balance as a reserve. The deductible is the number that has to be liquid.
And a sixth is leaving it behind at a former employer. It can usually be moved and consolidated.
Related
Roth IRA is the closest comparison on the way out. 401k is the other workplace account and usually the larger one. And index funds is what the invested portion normally holds.
A common failure is an account doing its job perfectly as a spending account and not at all as an investment one. The money goes in, the deduction is taken, and it sits in cash for fifteen years earning nothing — which converts a triple advantage into a single one nobody noticed losing.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.