The math
The health savings account is not a health account.
It is the only account in the US tax code taxed at no point. Every other account gives you the break going in or coming out. This one gives it at both ends, and most people who have one spend it every year on prescriptions.
Three exemptions, not two
Every tax-advantaged account makes the same basic trade. A traditional 401(k) exempts the money going in and taxes it coming out. A Roth taxes it going in and exempts it coming out. You are choosing which end to pay at, which is a bet on whether your rate will be higher now or later.
A health savings account does not make you choose. Contributions are deductible, growth is untaxed, and withdrawals for qualified medical expenses are untaxed. There is no end at which the government participates.
There is a fourth exemption that almost nobody mentions. Contributions made through an employer's plan also avoid payroll taxes, which no retirement account does. On $4,000 a year across 30 years, that alone is $9,180 that never left your pay in the first place.
The arithmetic
Worked example
$4,000 a year for 30 years at 7%, with assumed marginal rates of 24% ordinary and 15% long-term. $120,000 contributed in total
- HSA, spent on qualified medical
- $404,292
- Traditional 401(k), after tax
- $307,262
- Taxable brokerage, after tax
- $267,593
- Advantage over the 401(k)
- $97,030
Same contribution, same investments, same returns. The HSA finishes 31.6% ahead of the 401(k) and 51.1% ahead of the taxable account, purely because of how many times the money is taxed.
| Account | After 30 years, after tax |
|---|---|
| HSA, spent on qualified medical | $404,292 |
| Traditional 401(k) | $307,262 |
| Roth | $307,262 |
| Taxable brokerage | $267,593 |
Notice that the 401(k) and the Roth land on exactly the same number. That is not a coincidence or a rounding accident. When the tax rate going in equals the rate coming out, the two are mathematically identical, and the endless argument about which is better is really an argument about whether your rate will change.
That identity is useful here because it isolates what the HSA is actually doing. It does not win by betting on rates. It wins by removing a layer of tax that both of the others pay.
The prize scales with your bracket
| Marginal rate | HSA | 401(k) | Taxable | HSA advantage |
|---|---|---|---|---|
| 12% | $404,292 | $355,777 | $309,845 | $48,515 |
| 22% | $404,292 | $315,348 | $274,635 | $88,944 |
| 24% | $404,292 | $307,262 | $267,593 | $97,030 |
| 32% | $404,292 | $274,919 | $239,425 | $129,373 |
| 37% | $404,292 | $254,704 | $221,821 | $149,588 |
The HSA column never moves, because nothing about it is taxed. Everything else falls as the rate rises. At 12% the advantage over a 401(k) is $48,515; at 37% it is $149,588.
As with asset location, this is worth most to the households that already have the most. Worth saying plainly rather than pretending otherwise.
The mistake almost everyone makes
Treating it as a spending account.
The default behavior is to contribute during the year, pay this year's prescriptions and copays out of it, and finish near zero. Done that way the account is a modest discount on medical bills, worth your marginal rate on whatever passed through, and nothing else. The compounding that produces every number above never happens.
Used as intended it is the best retirement account available. Used as most people use it, it is a coupon.
The alternative is to pay current medical costs from ordinary cash, invest the HSA balance, and leave it alone for decades. Many providers keep the balance in cash by default and require you to opt into investing it, so this is usually an unmade choice rather than a considered one. Check whether yours is invested. A great many are not.
There is a further wrinkle worth knowing: qualified expenses can generally be reimbursed at any time after they were incurred, provided the account existed. Keeping receipts creates an option to withdraw tax-free later against spending you already did, which is a feature no other account has.
What happens if you never need it for medical
This is the objection that stops people, and it should not.
After a certain age, withdrawals for non-medical purposes are taxed as ordinary income rather than penalized. At that point the account behaves exactly like a traditional 401(k), finishing at $307,262 in our example, which is still 14.8% ahead of the taxable account.
So the downside case of an HSA is a traditional 401(k), and the upside case is tax-free. That is an unusually favorable shape for any financial decision, and it is the reason the account deserves to sit high in the order of operations, typically just after capturing an employer match.
It is also worth remembering that healthcare is one of the few expenses almost certain to rise in retirement. The scenario where you reach seventy having incurred no qualified medical costs is rarer than the objection implies.
What this leaves out
Eligibility. You need a qualifying high-deductible health plan, and that plan has to actually suit you. Choosing worse coverage to gain a tax break is a bad trade if you have ongoing medical needs, and no amount of compounding fixes an unaffordable deductible in a bad year.
Contribution limits. This essay prints none. They change annually, and when we last checked for the asset location essay, the IRS page publishing bracket figures still carried the prior year's numbers while commercial calculators disagreed with each other. Get them from the IRS for your year.
State treatment. A small number of states do not follow the federal treatment, so the deduction may not apply at the state level where you live.
And the cash flow assumption. All of this requires paying medical costs out of pocket while the account compounds. If you cannot comfortably do that, using the HSA for its stated purpose is the right answer and the arithmetic above is not aimed at you.
Sources and further reading
The arithmetic is our own and its assumptions are stated above. The account rules come from the IRS.
- Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, Internal Revenue Service. The authoritative treatment of eligibility, qualified expenses, and the tax treatment at each stage.
- Retirement topics: contributions, Internal Revenue Service, for current-year limits across account types.