Valuing an HSA’s Triple Tax Savings

Leaves Changing Color

If you have a high deductible plan, you likely have heard about the value of combining it with a health savings account (HSA) for triple tax savings.  But what does that really mean?  And can you quantify the value of that savings to see if it’s really worth it?  Yes you can!

There are a few ways that get an answer to that question, all of which will provide approximately the same answer.  I’ll review each in detail so you can see how it works.

Triple Tax Savings?

First off, let’s talk about what triple tax savings really means.  To start, think about a normal run-of-the-mill brokerage account.  It gets taxed in 3 ways:

  1. It’s funded with after-tax dollars, meaning you’ve already paid taxes on the income that generates those funds.  If you want to put $1,000 into the account, you’d actually need to earn $1,333 (assuming a 25% marginal tax rate) to be left with $1,000.
  2. After you put money into the account, any dividends generated by the investments have to have taxes paid on them every year.  You’ll have to take money out of the account to cover it, which reduces your money’s ability to compound over time.  Dividend taxes are typically 15%
  3. Lastly, when you sell your investments, you’ll owe capital gains tax on any gains.  This is basically the difference between the account’s value and whatever you contributed, less growth from dividends that were already taxed.  Capital gains taxes are typically 15% unless you’re in the 10%, 15% or 39.6% tax brackets.

When used correctly, an HSA avoids all three of these taxes, hence triple tax savings!  It’s essentially the best of all worlds: an up-front tax deduction like a 401k or traditional IRA, income deferral like all IRAs and tax free withdrawals like a Roth.

Let’s look at how it works:

HSA Contributions are Pre-Tax: No Taxes Upfront

There are two ways to get money into an HSA: payroll deduction through your employer or write a check yourself.

In the first case, your employer will make a contribution for you directly, then exclude it from the calculation for taxable income and withholdings.  The process is exactly the same as pre-tax 401k contributions.  At tax time, the taxable wages on your W-2 will exclude these contributions.

If you write a check yourself from your bank account, you’re technically making the contribution with after-tax dollars.  In this case, there’s a line on your tax return to include how much your contributed directly, which then gets removed from your taxable income.  The end result is the same, even if the path is slightly different: any HSA contributions are excluded from taxable income.

Tax-Free Growth on HSA Investments

An HSA’s second major tax benefit is that your money gets to grow tax free until you withdraw it.  Just like an IRA, this let’s you keep more of your money working for you and compounding returns.

Tax-Free Withdrawals (If you follow the rules)

If invested long enough, hopefully your HSA will have built up a nice balance in excess of whatever you contributed.  As long as you use the money for qualified healthcare expenses (see here for examples) then no tax is due on withdrawals.  It’s just like a Roth IRA, you can take the money out tax free because you already paid the taxes, except you didn’t have to pay the taxes!  It doesn’t get much better than this, folks.

The astute reader will notice that tax free withdrawals are possible only on qualified healthcare.  if you don’t follow those rules and use the money for something else, then Uncle Sam is going to stick you with a big bill.  In additional to having any withdrawals taxed as ordinary income (remember, contributions went in tax free, so the tax treatment is similar to a 401k), you’ll also get hit with a 10% penalty.  Depending on what tax bracket you’re in, you could end up losing nearly half of your account balance to taxes and penalties.  Ouch!

Calculating the Present Value of Tax Savings

Now that we’ve covered the basics of how an HSA’s triple tax savings work, let’s work on determining how much that’s worth.  You do that by comparing the performance of an HSA with the tax savings and a regular brokerage account without the tax savings.  Taxes avoided = incremental value of using an HSA.

Let’s start with a couple of simple assumptions for an example where we want to contribute $1,000 to a taxable account:

Time Horizon for Investment 20 Years
Investment Returns (Annual) 7%
Capital Gains Tax Rate 15%
Marginal Income Tax Rate 25%
Discount Rate 5%

At a 25% marginal income tax rate, you would actually need to earn $1,333 in income and then pay $333 in taxes in order to have the $1,000 after-tax to invest.

Assuming 7% annual returns (none from dividends in order to keep the math simple), your $1,000 would grow to $3,870 after twenty years and have unrealized gains of $2,870.  At a 15% capital gains tax rate, you would then owe $430 of capital gains tax.

HSA Growth Detail

So investing in a taxable brokerage with these assumptions yields two tax bills: $1,333 at year 0 and $430 at year 20.  At a 5% discount rate, the present value of those taxes is $496 or about 37% of the $1,333 you started with.

By investing in an HSA instead, you don’t have to pay any of those taxes, so the value of that tax avoidance is the same.  Think about this way: by using an HSA you would get an immediate $496 increase in value or a 37% return as a result of the tax savings.  While it’s true that these assumptions would have to play out and you would be realizing the value over a 20 year period, it’s value nonetheless.

Impact of Changing Assumptions

There are 4 key variables at play here in determining present value: discount rate, time horizon, investment return and tax rates.  Let’s look at each to see how changing them impacts present value.

Discount Rate

This is the rate we are using to bring future cash flows back to the present.  All else equal, the lower discount rate you assume, the more valuable the tax savings become, because they are being discounted less.

Time Horizon

Increasing the time your money is invested in an HSA increases the value of the tax savings.  This is because your money has more time to work in a tax advantaged form.

PV of Tax Savings - Time Horizon and Discount Rate

Investment Return

The higher returns you’re able to earn in the HSA the greater value of the tax savings.  One note, however, the value is really being determined by the gap between your investment return and discount rate.  If you’re discounting the tax savings back to the present at a greater rate than what you’re generating them at, you’re actually losing money!

PV of Tax Savings - Investment Return and Discount Rate

Tax Rates

In general, the higher your marginal tax rate, the more the HSA tax savings are worth to you.  You’ll notice, however, that these lines aren’t as smooth as they were in other graphs.  That’s because capital gains tax are treated differently depending on your income tax rate.  At a 10% or 15% income tax rate, there are no capital gains taxes, so you wouldn’t be paying them anyway.  The HSA isn’t worth as much to you.  At the same time, the top 39.6% tax rate means a 20% capital gains rate (or 23.8% if subject to additional Obamacare taxes).  That makes avoiding taxes more valuable than the middle brackets where capital gains are only taxed at 15%.

PV of Tax Savings - Tax Rates and Discount Rate

What About Dividends?

I ignored dividends in the examples above to keep the math simple, but if underlying investments pay dividends, an HSA becomes even more valuable.  It’s just another layer of taxes that are being avoided.  Additionally, dividend tax is paid every year, so it’s present value is much higher than capital gains that only come at the very end.

Sanity Check: Account Values

Here is one additional way to think about the value of an HSA: the amount of money you’ll have at the end compared to a regular taxable account.

Taxable vs. HSA Account Value

In both cases, you start with $1,333, but the taxable has to immediately pay income taxes that the HSA doesn’t.  Both accounts grow at 7%, but at year 20 the taxable account has to pay capital gains that the HSA doesn’t.

The HSA would have grown to $5,160 over 20 years, but the taxable only grew to $3,439.  That’s a difference of $1,720.  It makes sense the HSA balance would be greater, because the HSA’s tax savings had positive value.

Things You Can Do

  • If you have access to an HSA, fund it as much as you can to reap the maximum tax benefits.  It’s the only investment account with triple tax savings, so prioritize as much as possible.
  • Since you have to have a high deductible medical plan to have an HSA, it’s a great place to stash the difference in insurance premium each month.
  • If you can, avoid paying all but the biggest medical bills using the HSA to maximize the time the tax savings can work for you.
  • If you don’t need any of the HSA balance in the near future, invest as aggressively as you feel comfortable to maximize the tax savings.


An HSA is an incredibly powerful investment tool that if used correctly can generate significant tax savings over time.  It is the only investment account that has no taxes whatsoever, so count yourself lucky if you can get one.

Readers, do you use an HSA in conjunction with high deductible medical insurance?  How are you using it to maximize your own tax savings?

John started Present Value Finance in 2017 to share his experiences and insights on personal finance to help people make better decisions and take control of their financial lives.  

He achieved financial independence in 2016 by walking away from the high stress world of corporate finance to focus on his family. He’s a husband, father, family CFO, and all around finance geek.

One comment

  1. Thanks for that. When you combine taxes with the time value of money its deadly!
    I have a weird obscure GVUL plan through work that gives some tax free roll up. I’m now starting to think it’s more valuable than I had thought. Its not just the tax its the time value of those lost returns.

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