Triple tax advantaged Health Savings Accounts, or HSAs, can be one of your most powerful retirement savings vehicles, but not many Americans know how to fully utilize them. Only 4% of HSA owners hold invested assets; the other 96% use their account as a slush fund to pay for current medical expenses. To be clear, using your HSA as a slush fund is still much better than not using an HSA at all. Contributions to an HSA are tax-deductible, and come out tax-free when used for qualified medical expenses (contributions are always federal income tax-free, and state income tax free in every state but three). Even if your HSA isn’t invested and doesn’t grow, you’ll still get some great tax advantages.

Before we get into more advanced HSA strategies, let’s talk about the basics: how do you know if you can open an HSA or contribute? What types of expenses qualify for HSA reimbursement?

Basics of an HSA

To be eligible for an HSA, you must be enrolled in a qualified high-deductible health plan. For high-deductible health plans in 2022, the minimum deductible is $1,400 for individuals and $2,800 for families. The out-of-pocket maximum must be no greater than $7,050 for individuals or $14,100 for families. If you have a qualifying HDHP you still need to check one more box before opening your HSA: if your employer offers an FSA that can be used for medical expenses, you may not be able to use an HSA. However, if your employer offers a limited-purpose or post-deductible FSA, you may be able to use an HSA as well. The primary limited-purpose FSAs compatible with HSAs are for dependent care expenses.

Speaking of employer accounts, if your employer offers an HSA with direct payroll contributions, you may want to consider contributing there instead of through an outside HSA. Contributions through your employer will be exempt from FICA taxes in addition to income taxes, plus your employer may even offer an employer match. If your employer HSA doesn’t have the best investment options, your plan may allow you to transfer funds to an outside HSA with more attractive investment options.

Contribution limits to an HSA in 2022 are $3,650 for individuals and $7,300 for families. If you are 55 or older, you can contribute an additional $1,000 per year as a catch-up contribution. One overlooked advantage of an HSA is that contributions do not need to be from earned income. This means as long as you are enrolled in an HDHP and eligible to make HSA contributions, you can contribute, from whatever funds available to you. If you retire early and don’t have earned income, this benefit can be especially valuable.

What if I only have an HSA for part of the year?

Many Americans switch jobs and health insurance in the middle of the year, so it’s possible you might become HSA-eligible midway through the year. The good news is HSAs have a last-month rule: if you qualify for an HSA by December 1st, you can make the full annual contribution, even though you may have only been eligible for one month. However, you must remain HSA-eligible through December 31st of the next year for those contributions to remain valid. If you violate the testing period, those contributions will become ineligible and taxable.

What if I am no longer in an eligible plan but still have an HSA?

While you are not allowed to contribute to an HSA if not enrolled in a high-deductible plan, you can still spend down existing HSA assets. If you have an HSA but are no longer eligible to make contributions, you can still let your account grow or use it for qualified medical expenses; you are just no longer eligible to make new contributions until or if you become HSA-eligible again in the future.

When should I not use an HSA?

Even if you have the option to enroll in an HDHP and take advantage of an HSA, it may not always be the best decision. High-deductible health plans usually aren’t the most robust plans, so if you expect to have a significant amount of medical expenses, it may be financially optimal to instead enroll in a better health insurance plan or option through your employer. While HSAs are extremely powerful savings vehicles, if your high-deductible health insurance plan is costing you thousands of dollars extra per year in medical expenses, choosing a plan with better coverage may be worth considering. Having good health insurance is especially valuable during those strategic years of large medical procedures and surgeries and in years when you are expecting the birth of a new child.

What expenses can an HSA be used for?

HSAs can be used for a wide range of medical expenses, some that you may not even realize would qualify. IRS Publication 502 covers eligible and ineligible expenses, and when shopping for medical expenses, whether online or in-store, you’ll likely see “HSA-eligible” or “FSA-eligible” tags next to eligible items. There are even entire websites online that only sell FSA or HSA-eligible expenses.

After age 65, or if you are disabled, you can use HSA dollars for non-qualified expenses without being subject to a penalty, although you will be responsible for ordinary income tax. If you use an HSA for non-qualified expenses before age 65, you will owe income tax and a 20% tax penalty. It is best to use your HSA for qualified medical expenses, even after age 65, although if you have an overabundance of HSA assets you can essentially use it like a traditional IRA.

What is the best way to use an HSA?

Using your HSA as a slush fund is not a bad way to pay for medical expenses, as you are still getting tax breaks on those dollars, but there’s an even better way. Paying for medical expenses out-of-pocket and letting your HSA dollars grow is even more powerful since growth and qualified distributions will be entirely tax-free. If you have the cash reserves to cover medical expenses out-of-pocket, your HSA can be an extremely powerful retirement savings vehicle.

Most Financial Mutants know it’s best to save and invest HSA dollars, if possible, but fewer know the exciting rules regarding qualified expenses. There is no time limit for reimbursing yourself for qualified medical expenses, which means you can save your receipts for decades before reimbursing yourself entirely tax-free after your HSA has grown many times over. It is important to keep great records (electronic and physical, in multiple places) if you plan on saving receipts for decades.

HSAs are one of our favorite retirement savings vehicles. They are neck-and-neck with Roth IRAs for the title of “Best Place to Save.” HSAs offer a triple tax advantage; contributions go in pre-tax (reduce your taxable income), growth is tax-free, and qualified distributions are tax-free. As an added bonus, those using an HSA through their employer are exempt from FICA taxes on contributions. Don’t miss out on building these extremely powerful tax-free dollars. Your future self will be so thankful you did!

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