Cash HSA vs. Investment HSA – What You Need to Know

By Mark Yatros

Did you know that you may be sitting on an account that, in addition to its prescribed use, could help you save money for retirement? If you have a high-deductible health insurance plan and have a Health Savings Account (HSA), you can use the HSA as an investment account, and your money will grow tax-free.

If you’re intrigued, read on to discover how to benefit from this type of account that will save you money on medical expenses and allow you to enjoy tax advantages.

But first, what’s a Health Savings Account?

Health savings accounts are special savings accounts that let you set money aside on a pre-tax basis to pay for qualified medical expenses. Sounds good, right? Here’s a caveat, though: You must have a high-deductible health insurance plan to be eligible to open an HSA. You may be able to open an HSA through your employer, or you can open one on your own through a financial institution (FYI: Allegiant Wealth Strategies would be happy to help you with this).

Although HSAs usually can’t cover your health insurance premiums, you can use them to pay for most other medical-related costs, including copayments and deductibles. While HSAs are meant for medical expenses, you can withdraw money from your HSA for any reason; however, if you aren’t using the money for qualified medical expenses, you must pay a penalty tax. 

The money left in your HSA at the end of the year rolls over from year to year, so you can keep saving for future medical needs.

The two types of HSAs

There are two types of HSAs: cash accounts and investment accounts. Each type of account serves a unique purpose, depending on your financial goals and healthcare needs. Knowing the differences can help you use your HSA wisely. It can also guide you in planning for your current and future medical expenses.

Cash HSA

A cash HSA is the more straightforward of the two options. It works like a regular savings account, offering a safe and easily accessible place to store your HSA funds. With a cash HSA, your money is held in cash or cash-equivalent assets, meaning there’s little to no risk of losing value. This option is perfect for those who like to use their HSA for medical expenses as they come up. It ensures you have the funds available whenever you need them.

Paying for medical expenses with money from your cash HSA is generally straightforward. Most accounts are linked to a card that works like a debit card – you swipe it and enter your PIN or enter the info on your provider’s billing website. Some accounts may issue you checks to write against your HSA balance.

Investment HSA

An investment HSA allows you to grow your HSA funds by investing in different financial options such as stocks, bonds, or mutual funds. This works similarly to how you might invest in a retirement account and is a great way to make your money work for you.

While an investment HSA has the potential for more significant growth, it also carries more risk because your savings can fluctuate with the market. If you have the cash to pay for your current health expenses, have few health care needs, and are considering long-term growth, an investment HSA can be a good option. It can help you save for future medical expenses, especially those you’ll have in retirement.

To pay for medical expenses from an investment HSA, you may need to sell some of your investments if you don’t have a sufficient balance in the cash portion of your account. You can initiate the sale on your HSA’s website, which may take a few days to process. Once the sale is complete, the funds will be moved into the cash portion of your HSA. You can then use your HSA debit card, write a check, or reimburse yourself to cover the medical expenses. Be sure to keep all receipts and documentation for tax purposes.

Growth potential of investment HSAs

If you’re comparing a cash HSA versus an investment HSA, remember that cash HSAs are a stable, low-risk option where your funds are held in cash or cash equivalents. This results in minimal investment growth, but cash HSAs aren’t supposed to grow because they’re for paying your near-term medical expenses.

In contrast, an investment HSA allows you to invest your funds in stocks, bonds, or mutual funds, offering the possibility for much higher returns. While the investment HSA carries more risk due to market fluctuations, it also provides a significant opportunity to grow your healthcare savings over time, especially if you don’t need to use the funds immediately.

Like retirement accounts such as 401(k)s or IRAs, an investment HSA allows your money to grow through compound interest and market gains. Treating your HSA as a long-term investment vehicle enables you to accumulate a substantial fund to cover healthcare costs in retirement when medical expenses are likely to increase. This approach enhances your financial security and takes full advantage of the tax benefits associated with HSAs, making it a smart move for those planning for the future.

Tax implications of HSAs

One of the most attractive features of a HSA, either a cash or investment account, is its triple tax advantage.

1. Your contributions are tax-free. This means that if you have an income of $100,000 but contribute $8,300 to your HSA for your family, your taxable income would be reduced to $91,700.

2. Your contributions grow tax-free. Also, there aren’t any required minimum distributions, so if you don’t need to use the money for medical expenses, it and the interest you’ve earned will grow tax-free. 

3. Your medical distributions are tax-free. If you’re under age 65, funds can be withdrawn tax-free to pay all qualifying medical expenses. As an added bonus, once you reach 65, you can withdraw the money without a qualifying medical expense. However, you will pay regular income tax on the withdrawals.

Cash HSA tax considerations

A cash HSA requires little additional tax planning, making it an easy option for those who prioritize stability and simplicity in their financial planning.

Investment HSA tax considerations

An investment HSA adds another layer of tax considerations due to the nature of investments. While your contributions and growth are still tax-free, you’ll need to consider the tax implications of capital gains, dividends, and interest earned on your investments.

If you sell investments to pay for medical expenses, those transactions can affect your taxes, particularly if your investments have appreciated significantly. But, as long as the withdrawals are for qualified medical expenses, they remain tax-free, preserving the HSA’s overall tax advantage.

It's important to know what you’re getting into when opening an investment HSA. My team and I are here to help you understand the details. Please contact us here or call (269) 218-2100 to schedule a no-strings-attached consultation.

Which HSA type is right for you?

Choosing between a cash HSA and an investment HSA depends on several factors, including your financial goals, risk tolerance, and healthcare needs. If you prefer a low-risk, straightforward option and anticipate using your HSA funds soon, a cash HSA might be the best choice. It offers stability and easy access to your money without market volatility concerns.  

On the other hand, if you’re focused on long-term growth and don’t need immediate access to your funds, an investment HSA could work better for you. It allows you to take advantage of potential market gains, making it a good option if you have a higher risk tolerance and a long-term financial outlook.

We’re here to help

If you have questions about opening an HSA or which HSA is right for you, we’re happy to help. Please contact us here or call (269) 218-2100.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to ensure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Allegiant Wealth Strategies offers securities and advisory services through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Allegiant Wealth Strategies has offices in Battle Creek and Portage, Michigan, from which we serve Calhoun County, Kalamazoo County, and Kent County (Grand Rapids). The Allegiant Wealth Strategies team offers no-obligation financial planning consultations; call 269-218-2100 or contact us here.