According to recent research by the Employee Benefits Research Institute, only 60% of HSA owners contributed or received an employer contribution to their account in 2021.¹ As these accounts continue to grow in the workplace, investors may want to consider prioritizing an HSA as part of their financial and health wellness plans. We’ll start with an introduction of what HSAs are and how they differ from other account types, then discuss the benefits available with HSA ownership.

HSAs are tax-advantaged savings accounts available to those enrolled in an eligible HDHP and are designed to help investors pay for qualified medical expenses. Notably, they offer considerable tax benefits:

1. Contributions reduce taxable income.²
2. Investment growth is tax-deferred.
3. Qualified withdrawals are tax-free.

Provided that HSA funds are used to reimburse qualified health care expenses for an eligible person, the rules for HSA withdrawals are flexible. Investors can make a withdrawal at any point for any unreimbursed qualifying expense incurred since opening the account as long as they can provide a receipt.

For example, let’s consider an investor who pays $4,000 out of pocket today for their child’s braces. By saving the receipt, that investor can reimburse themselves for that expense later by withdrawing that same $4,000—tax-free—to pay for a nonmedical expense like college tuition or retirement costs. Making the most of this flexibility requires careful recordkeeping, but it also makes HSAs an attractive vehicle for a variety of long-term savings goals.

In addition to typical out-of-pocket costs, an HSA can be used to pay Medicare premiums (except for Medigap premiums) or to buy long-term-care insurance.³ The accounts are also portable, said Boris Wong, a Vanguard senior wealth planning researcher and co-author of the updated research paper Stretch Your Financial Muscles: The Unique Flexibility of HSAs. “When enrolling in an HDHP through work, an investor can stay with the HSA custodian chosen by the employer or transfer to another custodian,” Wong said. “Because HSA employee and employer contributions are fully vested from the account opening, should an investor leave their employer, they can take their HSA with them.”

If withdrawals prior to age 65 are used for something other than qualified medical expenses, they are subject to income taxes and a 20% penalty. For investors 65 or older, there is no tax penalty for nonqualified withdrawals, but income taxes are still due. HSA balances are also not subject to required minimum distributions (RMDs).

The advantages of an HSA are most obvious when compared with other long-term savings accounts, as seen below. Other considerations, including state tax treatment, can be found in the updated research paper.

HSAs’ tax advantages can translate into greater growth in spending power, and the longer the time horizon, the larger the potential advantage.

The “why” for using an HSA is straightforward, but the “how” can vary depending on financial goals.

First, investors who are enrolled in an eligible HDHP and do not have an HSA may want to consider opening one, whether through an employer or a custodian that offers self-directed HSAs.

“Next, for contributions that are already being maximized to all eligible tax-favored opportunities, including any employer match, nonmatched employer savings, IRAs, or 529 education savings plans, a possible next step is to fully fund your HSA,” said Clifford S. Felton, a Vanguard wealth planning researcher and co-author of the updated paper. “If you pay for near-term medical costs out of pocket, you could invest your HSA assets in low-cost funds that align with your financial objectives and give them the chance to grow and compound for as long as possible.”

However, investors often face budgeting constraints that limit how much they can save. Prioritizing how much to save in which type of account becomes key. What account prioritization order should they consider?

Once an employer’s match is secured on employer plan contributions, it might make sense to save the next dollar in an HSA rather than another type of account.⁴ The decision then becomes whether it is better to treat the HSA as a vehicle for long-term investment by saving, or to use it like a checking account for present medical expenses by spending. Using the HSA on current expenses allows the investor to harvest the tax benefits today, which is a certainly a positive, but doing also so takes away an opportunity to invest and give those benefits the chance to grow over time.

An investor’s perception of an HSA can evolve as well as balances and eligible expenses accumulate, making it more of a versatile savings option than a pure retirement plan. For instance, what an investor once considered a medical checking account may become an emergency account, college savings account, or long-term retirement savings account.

HSAs can be optimal in preparing for health care costs and saving for the long term. As each investor has unique needs, having a strategic long-term approach with budgeting and investment goals is key to maximizing the power of an HSA and harnessing it as a part of a financial wellness plan.

• Stretch your financial muscles: The unique flexibility of HSAs (14-page PDF, issued September 2023)
• Income-driven financial planning may help reduce taxes (article, issued August 2023)
• Maximizing household liquidity for today and tomorrow (article, issue June 2023)
• Vanguard’s guide to financial wellness (52-page PDF, issued January 2023)