5 Tips for Getting the Most Out of a Health Savings Account

Editor's note: We have published new research and enhanced our methodology. Read our evaluation of the best HSA providers of 2022.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Health savings accounts have unparalleled tax benefits, but many investors are still getting the hang of how to use them and how they fit in their overall financial plans. Joining me to share some tips for HSA investors is Christine Benz. She is director of personal finance and retirement planning for Morningstar.

Hi, Christine. Thank you for being here today.

Christine Benz: Hi, Susan. It's great to be here.

Dziubinski: Now, your first tip is actually related to flexible spending arrangements, or FSAs. Now, many people assume that they shouldn't bother with an FSA if they do have access to an HSA. But you say that's not always the case.

Benz: It's not, and it is true that if you are covered by an HSA and you're contributing to an HSA, you're only eligible to use what's called a limited purpose flexible spending arrangement, and that means that you can only use the funds for vision care or dental care. But I think that an FSA can make a lot of sense in this context if you're someone who is using your HSA as a long-term investment vehicle, so your plan is not to spend from it and so you're using other assets to cover your healthcare costs. Well, if you're doing that, it makes sense to use the limited purpose FSA up to whatever your expectation is for your dental and your vision costs for the coming year because you can take advantage of the tax advantages of that flexible spending arrangement. So, pretax contributions going in, tax-free withdrawals for qualified expenditures. So, I think that these two things can work hand-in-hand very effectively, especially for those HSA investors.

Dziubinski: Your next tip relates to the unfortunately not uncommon problem of people who have an HSA through their employer and maybe that HSA isn't that great. What's a workaround for those people?

Benz: Right. We've been doing our research on HSAs. Our team has been doing research on HSAs, attempting to improve the landscape for HSA investors. But we know that some of these HSAs are larded with lots of fees, lots of expenses, expensive investment accounts. So, the thing that people should know is that if the employer provided HSA is not great, you can still go ahead and contribute to it via payroll deduction. That's probably the most streamlined way to handle making the contribution if you want to take full advantage of the tax benefits. But then, you can periodically transfer to the HSA of your own choosing, and that's where I think our HSA ratings can really come in handy, where you can look at your use case for your HSA and do those periodic transfers--so contribute to the employer-provided HSA, then transfer out to the HSA of your choice. There's nothing saying you can't have more than one HSA going at a given point in time.

Dziubinski: Now, your next tip relates to emergency cash needs, and you think HSAs can play a role there. Tell us about that.

Benz: I do. And it gets a little bit confusing. But again, for people who are using their HSAs as long-term investment vehicles, the HSA can serve as a backup emergency fund. So, if you've paid out-of-pocket, if you've used non-HSA assets to cover healthcare costs, you can later tap that HSA for non-healthcare-related costs. As long as you have documentation to show, "Hey, I paid these healthcare expenses using non-HSA expenses," as long as you have that documentation, you can take a tax-free withdrawal from the HSA even if it's not for a healthcare cost. So, it's a valuable escape hatch that exists within HSAs. I think people, if they knew more about it, might be more comfortable using the HSA as kind of a backup emergency fund. You would want to invest it accordingly, though. If there's a risk you may need to tap it, you wouldn't want it to be all equities, for example. You would want to have some liquid assets that you could pull from.

Dziubinski: Christine, you also point out that an HSA can come in handy when it comes to paying for long-term care. How do you go about that?

Benz: Well, you can use your HSA to pay long-term-care costs as they arise. You can also use HSA assets to pay long-term-care premiums. So, if you're purchasing insurance, you can use the HSA. There are limits on how much of your HSA you can use based on age. So, check that out. But that can be a way to purchase insurance to use HSA funds. So, a couple of different things to think about there.

Dziubinski: And then, lastly, your final tip relates to how people should use an HSA in retirement. It can be effective, but you should make sure that you spend down those HSA assets during your lifetime. Talk about that.

Benz: Right. An HSA can be a terrific thing to bring into retirement because you can use the funds for healthcare expenditures. Many older adults have higher healthcare outlays later in life. So, it can come in handy there. But the key thing you want to think about is that the HSA funds need to be spent within your lifetime or your spouse's lifetime. Otherwise, if someone inherits them from you, it's essentially like the tax benefits are going away. So, there are some great tax benefits; just make sure that you spend from them during your lifetime or your spouse's lifetime.

Dziubinski: Well, Christine, thank you so much for your time today and for your perspective about how to really make the most of a health savings account. We appreciate your time.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.