Should I Max Out My HSA?

The health savings account (HSA) is actually a pretty cool idea.

If you have an eligible high-deductible health plan (more on that below), you can open an HSA and enjoy triple tax protection:

  • Contributions to an HSA are pretax (they’ll lower the taxes you owe this year)
  • You can invest in a mutual fund and it will grow tax-free
  • As long as you use the money for medical expense, you won’t be taxed on the withdrawals

This isn’t an account where you need to use the money this year. The money is yours just like a 401k or IRA.

So should you max out your HSA?

That’s impossible for me to say. But I don’t plan on maxing out mine. Let’s dive into why.

The Benefits of an HSA

We’ve actually already done a pretty good job laying out the benefits of an HSA: The tax savings.

As long as you use the money for qualified medical expenses, it’s protected from taxes at every stage the government might possibly want to tax it.

It’s probably the most tax-efficient investment I’ve ever heard of.

And let’s face it, you unfortunately will have plenty of medical expenses as you get older.

The Drawbacks of an HSA

Of course, the downside of the HSA is that you’re basically saving just for medical expenses. This is in many ways smart and important, but it’s not very fun.

What happens when you use your HSA for something other than a qualified medical expense? Well, in addition to paying taxes, you’ll be hit with a hefty 20% penalty. Ouch.

HSA Contribution Limits

Here are the annual contribution limits in 2021 (they’re getting increased in 2022)

  • $3,600 for an individual ($3,650 in 2022)
  • $7,200 for a family ($7,300 in 2022)

Let’s look at what happens if you invested the max throughout a normal working career. I’m going to assume that you started as an individual, switched to the family limit at age 26, and got a 5% return on your investment:

Should I max out my HSA?

Now granted, this is assuming you never take anything out for medical expense along the way. And it’s highly unlikely that very many people will max out their HSA for this many years. And it is possible that a diabetic with severe complications will need this kind of money to cover medical costs.

But all that said, over $800,000 set aside from medical expenses seems…excessive to me.

And of course, the real drawback is the fact that it’s probably not the first investment you should be allocating your money to.

AccountContribution Limit
Traditional or Roth IRA$6,000

Listen, if you have a family and still have the bandwidth to invest $32,700 a year, my hat is off to you. Maybe you should max out your HSA if you prefer that to putting money in a taxable account.

I just think that most people are going to tap out well before they are able to max out all their tax sheltered accounts.

Prevention vs. Cure

The HSA is a great hedge against the risks that come with aging, but it’s not the only hedge.

They say that an ounce of prevention is worth a pound of cure. When you live in a country with outrageous healthcare costs, that might be the understatement of the century.

Most people are going to spend their twilight years managing various preventable chronic diseases. In fact, this is one of the primary reasons why healthcare is so expensive in the U.S.

So you could plan for your eventual medical bills, or you could strive to be healthier than most people.

My preferred health interventions are intermittent fasting (daily time restricted eating and monthly 3 day water-only fasts), sugar restriction, 5x weekly kettlebell workouts (24 kg), walking, playing with my kids, getting good sleep, and some deep breathing before bed.

Will this be enough to keep me fit and healthy until I’m dead? I don’t know. But I’m in far better shape than the average 34 year old (which unfortunately is a pretty low bar to clear).

I still do put some money in my HSA. It’s nice to have an additional hedge in case my lifestyle interventions don’t pan out. But plan A is prevention. I’ve declared a preemptive war on type II diabetes and I intend on winning.

High Deductible Health Plans

One other thing that we should mention is that you’re only eligible to open an HSA if you enroll in a high deductible health insurance plan.

Since I know when you woke up this morning you were desperately hoping for a little insurance talk, I’m going to go ahead and scratch that itch for you.

In general, a plan that only covers preventative services and has an individual deductible of $1,400 or family deductible of $2,800 should qualify as high deductible. The deductible is what you have to pay out of pocket before most of the insurance benefits kick in.

So you want a lower deductible right? Well, all things equal, yes. But all things are never equal. The tradeoff of a low deductible is high premiums (the amount you pay to have insurance).

I prefer a high deductible, low premium plan because I’m young and healthy and don’t expect to need insurance very often.

That said, I switched away from my high deductible plan for the first 6 months of 2013. That was the year when my son was born. Anticipating hefty hospital bills, I switched to a high-premium, low-deductible plan during my company’s open enrollment in November 2012. Then after he was born I declared a “life event” (the birth of a child) allowing me to switch back.

The Biggest Benefit of the HSA (In My Opinion)

One way to use your HSA is to regularly save for later medical expenses, then contribute extra any time you actually have medical bills before you retire.

In other words, pick an amount to contribute to your HSA to save for future expenses. Maybe one or two thousand dollars. Then, if you have medical bills this year, put the money to cover them into your HSA and pay with your HSA card.

This is essentially a hack to save money on taxes whenever you have to pay for medical expenses.

But wait a minute, you might be thinking, aren’t medical expenses already tax deductible?

Look, I know we just hit insurance and now we’re talking taxes. I’m so sorry. Please just stay with me.

It turns out that medical expenses are rarely tax deductible.

The first reason is that in order to deduct medical expenses from your income, you have to itemize your deductions instead of taking the standard deduction. Most people end up going with the standard deduction because it’s freaking huge.

Seriously. The 2021 standard deduction was $12,550 for individuals and $25,100 for married couples. So unless you spent more than that on tax-deductible items, no, your medical expenses aren’t tax-deductible.

Even if you do itemize your taxes, you can only deduct medical expense that exceed 7.5% of your adjusted gross income. So if you make $50,000 a year and had $4,000 in medical bills, $3,750 would represent 7.5% and only the last $250 would be tax deductible.

Final Thoughts

Wow, taxes and insurance in one post. I am so sorry about that and thank you for reading this far.

I have an HSA, and I like it. I contribute to it regularly. If you think a high deductible insurance plan is a good fit for you, I also recommend checking out an HSA.

But I don’t have any plans to max it out. If I randomly stumble into a few years of exceptionally high income, I’d probably consider maxing out my HSA in those years only.

But for the most part, I’m going to invest a little and use it to pay for medical expenses tax-free.

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