When it comes to health savings accounts (HSAs), many people wonder if maxing out this unique financial tool is the best move. At first glance, the idea sounds appealing: With tax-free contributions and rollover privileges, there is both potential investment growth and the freedom to use the funds for medical expenses anytime. But is it the right choice for everyone? Should you max out your HSA?
While maxing out may help you unlock the full benefits of your HSA, it’s not the right answer for everyone. Let’s explore how to strategically use your HSA to maximize your savings.
To clarify: what is an HSA?
An HSA is a tax-advantaged account that lets you set aside pre-tax money to cover qualified medical expenses if you're enrolled in a high-deductible health plan (HDHP)—a type of health insurance plan with higher deductibles and lower premiums compared to traditional plans. You can use this untaxed money for things like deductibles, copays, and coinsurance, which can help lower your healthcare costs.
One great perk is that any money you don’t use rolls over year after year, letting you save—and even invest—your balance for future medical expenses. (This is just one key aspect that differentiates an HSA from a flexible spending account (FSA).) Plus, contributions, earnings, and withdrawals (as long as they’re for qualified expenses) are all tax-free, making an HSA a valuable tool for both immediate and long-term healthcare needs.
What does it mean to max out your HSA?
Maxing out your HSA means contributing up to the maximum limit set by the IRS for the year. For 2024, these limits are $4,150 for individuals and $8,300 for families, with an additional $1,000 allowed for those 55 or older.
This approach leverages the HSA's unique triple tax advantage:
- Tax-free contributions: Reduces taxable income
- Tax-free growth: Earnings accumulate tax-free
- Tax-free withdrawals: No taxes on funds used for qualified medical expenses
Maximizing your HSA contributions can support long-term financial goals, as it could double as a retirement fund. After age 65, withdrawals for non-medical use incur only regular income taxes, with no penalties.
Pros and cons of maxing out your HSA
Maxing out your HSA can be a strategic financial move, but like any decision, it comes with both pros and cons.
“Key advantages of maxing out an HSA include tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses,” says Nischay Rawal, a certified public accountant at NR Tax & Consulting. On the other hand, the cons may include limited use for non-medical expenses before age 65, and potential penalties for non-qualified withdrawals.
Pros of maxing out your HSA
- Tax savings: Contributions are tax-deductible, reducing your taxable income for the year.
- Growth potential: Some HSAs plans allow you to invest your balance for tax-free earnings, while others simply hold funds without significant interest. Check with your provider for options.
- Triple tax advantage: Contributions, growth, and withdrawals for qualified expenses are all tax-free.
- Rollover funds: Unlike flexible spending accounts (FSAs)—which are accounts that allow you to use pre-tax dollars for qualified medical expenses within a given year—your HSA funds roll over year to year, ensuring no money is lost.
- Retirement benefits: After age 65, you can withdraw HSA funds for non-medical expenses without a penalty (though income taxes will apply).
Cons of maxing out your HSA
- Restricted usage: To avoid penalties, you must use HSA funds only for qualified medical expenses, which limits flexibility before age 65.
- High-deductible requirement: You must be enrolled in a high-deductible health plan (HDHP) to contribute, which may not be the best fit for everyone.
- Investment risks: While investing your HSA can boost long-term growth, it also introduces market risk—especially if you need those funds in the near future.
- Opportunity cost: Maxing out your HSA might mean you put less money toward other savings vehicles like a 401(k) or IRA.
“So, should I max out my HSA?”
Deciding whether you should max out your HSA depends on your current financial situation. Ask yourself: Are you financially prepared for out-of-pocket medical costs? Are you maximizing contributions to other retirement accounts like your 401(k)?
“it's a good idea to fully maximize HSA contributions if one has a high-deductible health plan (HDHP) and can afford to do so,” Rawal says. On the flip side, ““situations where you shouldn’t max out include having immediate financial needs or insufficient funds to cover the deductible.”
Joseph Eck, certified financial planner (CFP) and owner at Stage Ready Financial Planning, offers this example: “It can be a smart strategy if you’re in a higher tax bracket and you've already contributed enough in your 401(k) to receive your full employer match.” In this case, you’d leverage the tax advantages of an HSA, especially when certain financial goals are already met.
Bottom line: If you're in a strong financial position and can cover short-term healthcare costs, maxing out your HSA may give you a financial edge, particularly since HSA funds can be saved or invested for long-term growth.
Bonus tips for maximizing HSA contributions
- Automate contributions. If possible, automate your contributions to ensure you hit the annual max without hassle. Set up direct deposits from your paycheck or recurring transfers from your bank account to your HSA. This ensures consistent contributions and helps you reach the annual max effortlessly.
- Leverage employer contributions. Many employers offer HSA contributions—don’t leave this free money on the table.
- Catch-up contributions. If you’re 55 or older, take advantage of the “catch-up” contribution limit to boost your savings. This allows you to contribute an additional $1,000 beyond the standard IRS limit each year, helping you grow your HSA balance more rapidly as you approach retirement.
- Invest smartly. Once your balance hits a comfortable level for medical expenses—typically enough to cover at least one year of out-of-pocket costs, including your insurance deductible and expected copays—consider investing the rest for long-term growth.
- Regularly review your healthcare needs. Adjust contributions accordingly to avoid tying up too much cash. For example, if you expect fewer medical expenses, you might contribute less to your HSA and focus on other savings. On the other hand, if you anticipate higher healthcare costs, such as surgery or ongoing treatments, you could increase your contributions to prepare.
- Use it as a retirement strategy. After age 65, you can withdraw HSA funds for non-medical expenses without penalties, though income tax will apply. This makes your HSA similar to a traditional IRA or 401(k), providing a flexible source of retirement income while taking advantage of the tax-free growth the account has accumulated over the years.
Incorporating these strategies can help you make the most of your HSA and better align it with your overall financial plan.
FAQs
Should I prioritize HSA or 401(k)?
It depends on your financial goals and current situation. “Factors like available employer match in the 401(k), current and future medical expenses, and tax considerations all play a role,” Rawal says. “Maxing out HSA contributions first can be beneficial due to the triple tax advantage.” This approach emphasizes the long-term advantages of an HSA for those who prioritize healthcare savings and tax efficiency.
Another approach is making the most of employer contributions before turning to the HSA for additional savings. “Taking advantage of free money by contributing enough to receive your full 401(k) employer match should likely come first,” Eck says. “Once you are receiving this match, maximizing your HSA contributions can be a great way to begin investing and saving for retirement healthcare costs.”
Both strategies have their merits, and the right approach depends on your financial priorities—whether you focus on tax savings for healthcare or securing your employer’s 401(k) match first. If you're still unsure which path fits best for you, consider reaching out to a certified financial planner who can provide personalized guidance based on your specific financial situation.
Should I withdraw excess HSA contributions?
Yes. “If you’ve over-contributed, it's wise to withdraw the excess amount and any earnings on the excess before the tax filing deadline to avoid penalties,” Rawal says. If the excess remains in your account past the deadline, you'll face a 6% penalty each year it goes uncorrected. Alternatively, you can apply the excess to next year's contributions to avoid the penalty altogether.
Should I invest my entire HSA?
That depends on your healthcare needs and risk tolerance. “Investing the entire balance of an HSA can be wise for those who don't need the funds for immediate medical expenses and want to grow their savings,” Rawal says. While investing part of your HSA can drive long-term growth, keeping a portion liquid for immediate or unexpected medical costs is prudent. “You should weigh your risk tolerance, investment options, and potential medical costs,” Rawal says, ensuring a balanced approach for both short-term needs and long-term gains.
Can I take money out of my HSA?
Yes, but to avoid taxes and penalties, you must use the funds for qualified medical expenses. If you withdraw for non-medical purposes before age 65, you'll face income taxes plus a 20% penalty on the amount withdrawn. After age 65, non-medical withdrawals are subject to income taxes but no penalties.
What happens to my HSA if I switch health plans?
Even if you switch to a health plan that’s not HSA-eligible, you can still keep and use your existing HSA funds for qualified medical expenses. The money in your HSA remains yours and can be used tax-free for healthcare costs, even if your new plan doesn’t allow new contributions. However, you won’t be able to contribute new funds to your HSA unless your new plan qualifies as a high-deductible health plan (HDHP).