The tax code is a monument to complexity and tedium. Once in a while, however, a few lines of text buried deep in a subchapter can produce a sleeper hit, an account or a planning strategy that goes on to play an outsize role in our financial lives.

The 401(k) plan is one example. The 401(k) plan originated in 1978 as a tax-code curiosity, an obscure deferred compensation provision. Today, it commands center stage in workplace retirement plans.

The health savings account (HSA) may become another. In 2003 Congress created the HSA for use with a high-deductible health plan (HDHP). These plans typically charge lower premiums than traditional health plans but impose higher deductibles. Enrollment in HDHPs, and, thus, access to HSAs, are growing rapidly.1

Contributions to an HSA benefit from tax breaks to help defray these higher costs. These tax breaks are attracting people interested not just in paying for health care but also in saving for long-term goals, such as retirement or a child’s education.


A tax-break trifecta

With most tax-advantaged accounts, you pay taxes now (a Roth IRA) or later (a traditional IRA). The HSA offers a third option: Never. Your clients may not be aware that contributions to an HSA are tax-free. The money compounds tax-free. And withdrawals are tax-free, provided they’re used for qualified medical expenses.

That last clause may sound restrictive. For most of your clients, it’s not. Even if they’re lucky enough to make it to retirement without ever setting foot in a doctor’s office, they can use the funds accumulated in an HSA to cover Medicare premiums or to pay for long-term care insurance.

And money is fungible. If clients weren’t paying Medicare premiums with funds from an HSA, they would pay them from another, less tax-advantaged source, such as a traditional or Roth IRA or a taxable account.

In new research, HSAs: An off-label prescription for retirement saving, we compare the growth of $1 saved in various accounts (technically, $1 of marginal income sheltered in each account). The hypothetical example below shows that $1 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 grows to $2.19.


The favored tax status of HSAs can boost long-term savings

$1 of marginal income

The favored tax status of HSAs can boost long-term savings

Note: This hypothetical illustration does not represent the return on any particular investment, and the 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 tax rate. Lower tax rates may make the taxable investment more favorable and the difference between taxable and tax-deferred less. Any future changes in the tax treatment of investment earnings or a rate of return that is lower than the assumed rate of return may further affect the comparison. Investors should consider their time horizon and current and expected future tax rates before making an investment decision.

Source: Vanguard calculations.


An underappreciated benefit of this favorable tax treatment is that contributions to an HSA can increase your client’s ability to save. If your client is eligible to open an HSA and expects to incur out-of-pocket health care costs at some time in the future, taxes saved on HSA contributions free up cash to set aside for retirement, an emergency fund, or another savings goal.


Complexity and opportunity

Consider HSAs an addition to the tool kit that you can use to help clients meet a variety of goals. For some, the HSA may make sense as a kind of medical checking account for current health care expenses. For others, it may be most powerful as a uniquely tax-advantaged, long-term savings vehicle.

As with any creature of the tax code, HSAs are governed by complex rules. Your guidance is key to helping clients navigate this complexity so they can take full advantage of their benefits.

In its versatility and power, the HSA has the makings of a hit.



 1 Paul Fronstin, 2017. Trends in Health Savings Account Balances, Contributions, Distributions, and Investments, 2011–2016: Statistics from the EBRI HSA Database. Washington, D.C.: Employee Benefit Research Institute. (EBRI Issue Brief Number 434.)


We recommend that you consult a tax or financial advisor about your individual situation.