The HSA Playbook: Three Layers Most People Skip

The account you already have that you're probably using wrong

Most people who live below their means are already ahead of most people who don't. You're not spending everything you make. You're building some kind of margin. That's not a small thing. Most Americans are not doing it.

But margin by itself is just a number sitting in an account. Where it goes next is what determines whether it compounds or just waits.

If you're on a high-deductible health plan, there's a good chance you have access to an account that does something no other account in the tax code does: it avoids taxes on the way in, avoids taxes while it grows, and avoids taxes on the way out, if you use it right. A Roth IRA avoids taxes on growth and exit but not the contribution. A 401(k) avoids taxes on the contribution and growth but not the exit. The HSA is the only account that does all three.

Most people who have one are using it as a spending account. That's not wrong. It's just layer one. There are two more.

By the end of this issue you'll know what all three layers look like, which one most people stop at, and what it actually takes to use the other two.

Look at your health insurance card or your benefits summary and find your deductible. If it's at least $1,700 for yourself, or $3,400 for a family plan, you're already eligible. That's the only requirement. The IRS calls a plan like yours a high-deductible health plan, and having one is what opens the door to an HSA.

From there, you can put in up to $4,400 this year for individual coverage, or $8,750 if you're covering a family. If you're 55 or older, you get an extra $1,000 on top.

The account works differently from an FSA in ways that matter. Your balance carries forward every December 31 instead of resetting to zero. It stays in your name when you change employers. And unlike most benefits accounts, you can move the balance into investments instead of leaving it as cash. That last part is what most people never do, and it's the biggest gap in how this account gets used.

Every dollar you put into an HSA goes in before taxes, which means if you're in the 22% bracket, a $4,400 contribution costs you about $3,432 out of pocket. The government is effectively covering the rest. That discount applies whether your employer offers payroll deduction or you contribute on your own and deduct it on your taxes.

Most people who have an HSA are doing this part. It's the default — the account exists, HR explained it during open enrollment, so you put some money in when you signed up. The tax benefit is real and it's worth capturing. But it's also the smallest layer of the three.

If you're contributing and then spending those funds on medical expenses within the same year, you're getting the tax deduction and you're covering costs at a discount. That's fine. It's just not the whole strategy.

Here's the one that most people miss. According to EBRI's 2024 HSA Database, 82% of HSA account holders keep their balance entirely in cash. They're collecting the tax deduction, but the money is sitting in a savings account earning close to nothing while the rest of the market compounds without it.

The reason most people stop at Layer 1 has nothing to do with the rules. HSA funds can be invested in mutual funds, ETFs, or index funds, the same vehicles you'd use in a 401(k). The difference is that HSA money is triple tax-advantaged, so the compounding happens without the drag of annual taxes on gains.

Here's a concrete scenario. A 35-year-old contributes $4,400 per year to an HSA and invests the balance in a low-cost index fund. They cover their out-of-pocket medical costs from their regular checking account and don't touch the HSA. At a 7% average annual return compounded monthly, that account reaches roughly $447,000 by age 65. That number grows tax-free the whole way there, and if it's spent on qualified medical expenses, it comes out tax-free too.

If the same person had kept it in cash for 30 years, they'd have around $132,000. That's 30 years of contributions with no compounding growth behind them.

The math on that gap is the reason Layer 2 matters. The account isn't just a tax break. It's a long-term investment vehicle with better tax treatment than anything else in the tax code.

One thing to check before you invest: most HSA providers require a minimum cash balance in the account, usually somewhere between $500 and $1,000, before they'll let you put the rest into investments. Log into your HSA provider's portal, find the investment section, and move whatever's above that floor into a low-cost index fund.

This is the layer almost nobody uses, and it's the one that takes the most patience to build.

Say you paid a $400 dental bill out of your checking account last March instead of touching the HSA. That receipt is still good. You can pull $400 out of the HSA this year, next year, or ten years from now, as long as the account was open when you paid the bill and you kept the paperwork. There's no deadline the IRS sets on when you collect the reimbursement.

What that means in practice: you can let your HSA invest and compound for decades while you cover current medical costs from regular income. Then at any point that makes sense, whether that's when you need liquidity, when you retire, or whenever it's most advantageous, you pull out whatever you've accumulated in receipts and reimburse yourself.

A household with routine medical expenses of $3,000 per year accumulates $30,000 in reimbursable receipts over 10 years. If the HSA grew at 7% over that same decade on a $4,400 annual contribution, the account would be worth roughly $63,000. Pulling out $30,000 in reimbursements doesn't cost a dollar in taxes because every one of those original expenses was qualified.

For documentation, you need the EOB your insurer sends after a claim, your prescription receipts, and any other qualifying bills. A folder of PDFs sorted by year works fine. No special app, no accountant required. Someone who opened an HSA at 35, paid medical expenses out of pocket for 25 years, and kept every receipt along the way can pull all of it out at 60 as a single tax-free withdrawal.

This layer doesn't require more income. It doesn't require a different health plan. It just requires the patience to not touch the account and the discipline to save a piece of paper.

If you contribute and then use the HSA as a debit card for every copay, you're still getting a tax break. That's not a mistake. It's the minimum effective use of the account.

The gap between using Layer 1 and using all three comes down to one question: do you have enough cash flow elsewhere to cover your out-of-pocket medical costs without touching the HSA? If yes, Layer 2 and Layer 3 are available to you right now. The account is already open. You just have to change what you do with the balance.

If your cash flow is tight and you need the HSA to cover medical expenses as they come up, that's fine. Layer 1 is still real value. Come back to Layers 2 and 3 when the margin is there.

This is not a recommendation to avoid using your HSA for medical costs. If you have a high-deductible plan and the HSA is the only account that covers your deductible, use it. The strategy above requires cash flow outside the HSA to work. If you don't have that margin yet, Layers 2 and 3 are a future decision, not a current one.

This is also not specific investment advice. The investments inside an HSA carry the same risk as any market investment. The tax treatment is favorable, but market returns are not guaranteed.

Issue #15 covers something that comes up whether you're single, married, or somewhere in between: how to think about combined finances when two incomes are involved. There's a set of decisions that couples tend to figure out by accident and then live with for years. Next week we build a framework for making them on purpose.

— Wesley

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