11 July 2020
Andy Clarke
Corporate Communications at Vanguard
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Health savings accounts (HSAs): The tax code’s next sleeper hit
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The tax code is a monument tocomplexity and tedium. Occasionally, however, a few lines of text buried deepin a subchapter can produce a sleeper hit—an account type or planning strategythat assumes an important role in our financial lives.

The 401(k) plan is one example.Originating in 1978 as a tax-code curiosity, this deferred-compensationprovision commands center stage in workplace retirement plans today.

The health savings account (HSA)may become another. In 2003, Congress created HSAs for use with high-deductiblehealth plans (HDHPs) which typically charge lower premiums (the amount you payevery month) than traditional health plans, but impose higher deductibles andother costs (so you have to pay more out of pocket before your insurance startsto chip in).

The tax treatment of HSAcontributions can help ease the potential burden of these higher out-of-pocketcosts. Combined with the HSA’s flexibility, these tax breaks are attractingpeople interested not only in paying for health care, but also in saving forlong-term goals such as retirement or a child’s education. Enrollment in HDHPs,and thus access to HSAs, is growing rapidly.*

A tax-break trifecta 

With most tax-advantagedaccounts, you pay taxes on contributions now (a Roth IRA) or later (atraditional IRA). The HSA gives you a third option: never.

With an HSA:

  • Contributions are tax-free. In 2017, the maximum contribution for an individual (including any employer contribution) is $3,400. For a family, it jumps to $6,750. If you’re 55 and older, you can contribute an additional $1,000.
  • Earnings are tax-free. You can keep HSA contributions in cash or invest them in longer-term assets like stock and bond funds. Unused contributions can roll over from year to year.
  • Withdrawals are tax-free, as long as you use the money for qualified medical expenses.

That last clause may soundrestrictive. For most of us, it’s not. Even if we’re hale, hearty—andlucky!—enough to make it to retirement without ever setting foot in a doctor’soffice, we can use the funds accumulated in an HSA to pay Medicare premiums orto pay for long-term-care insurance.

HSAs can boost long-termsavings 

In new Vanguard research, HSAs: An off-labelprescription for retirement saving, we compare the growth of $1 of incomesaved in various accounts. The hypothetical example below shows that $1 ofearnings invested in a traditional or Roth IRA (assuming a constant tax rate)will be worth $1.64 in 20 years. Put that same dollar in an HSA, and it growsto $2.19.

The favored tax status of HSAscan boost long-term savings 

$1 of marginal income 

Vanguard HSA Chart 10-4-17 

Note: This hypotheticalillustration does not represent the return on any particular investment, andthe return rate is not guaranteed. Calculations assume a 4% annual real return,a 2% annual income return, a 25% income tax rate, and a 15% capital gains taxrate. Lower tax rates may make the taxable investment more favorable and thedifference between taxable and tax-deferred less. Any future changes in the taxtreatment of investment earnings or a rate of return that is lower than theassumed rate of return may further affect the comparison. Investors shouldconsider their time horizon and current and expected future tax rates beforemaking an investment decision.

Source: Vanguard calculations.

Contributions to an HSA canincrease our ability to save. If you’re enrolled in an HDHP, and expect toincur out-of-pocket health care costs in the future, taxes saved on HSAcontributions may free up cash to set aside for retirement, an emergency fund,or another savings goal.

Complexity and opportunity:How to use an HSA effectively 

As with any creature of the taxcode, the rules governing HSAs are complex. But this complexity rewards carefulstudy.

Consider HSAs an addition to thetool kit we can use to meet a variety of goals. For some of us, the HSA maymake sense as a checking account for current or future health care expenses.For others, it may be most valuable as a uniquely tax-advantaged long-termsavings vehicle.

Whatever your reason for openingan HSA, one thing is clear: The versatility and power of the HSA has themakings of a hit.

*Fronstin, Paul. 2017. Trendsin Health Savings Account Balances, Contributions, Distributions, andInvestments, 2011-2016: Statistics from the EBRI HAS Database. Employee BenefitResearch Institute Issue Brief No. 434. 


  • All investing is subject to risk, including the possible loss of the money you invest.
  • We recommend that you consult a tax or financial advisor about your individual situation.
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