What is a Health Savings Account (HSA)?
A Health Savings Account, or HSA, is a tax-advantaged savings account for paying medical expenses that is available to consumers with high-deductible health insurance plans. Unlike a flexible spending account, an HSA does not have a deadline for spending the funds. It can be set aside to cover health care costs in retirement.
Here’s what else you need to know about health savings accounts.
How an HSA works
The tax benefits of an HSA are only available if it is used to pay for eligible medical expenses such as payments for doctor’s visits, prescriptions, ambulance services, eyeglasses and more. The IRS has a list of eligible medical expenses.
The federal government sets upper limits for reimbursable medical expenses. For 2022, the maximum an insured can be required to pay out of pocket is $7,050; the limit is $14,100 for a family. Once the insured has reached the maximum payout, the insurance company must cover the rest.
HSAs usually come with a debit card or checks to make it easier and simpler to pay medical bills.
HSA funds are renewed year after year. There are no required minimum distributions or withdrawal periods. Any money you put in your HSA stays there until you use it.
HSAs are also portable. If you change jobs or health insurance plans, your HSA goes with you.
If you’re 65 or older and enrolled in Medicare, you can no longer contribute to an HSA, but you can still use the money you’ve accumulated in the account to pay for medical expenses.
How to get an HSA
To qualify for an HSA, you must be enrolled in a high-deductible health insurance plan and have no other health insurance. You cannot be claimed as a dependent on someone else’s tax return or eligible for Medicare.
The IRS sets the thresholds for what is considered a high-deductible health plan. For 2022, an eligible insurance plan has a deductible of at least $1,400 for an individual or $2,800 for a family.
Not all plans with a high deductible qualify, so when shopping for an HSA, look for plans that say “HSA-eligible.”
Your employer may offer HSA-eligible insurance plans. You can also find financial institutions that offer these accounts. BMO Harris Bank and Bank of America offer HSAs, for example. Applying for an HSA at a bank is similar to opening a savings account. You must complete an application and provide basic information, such as your social security number, date of birth, physical address, phone number, and a valid email address.
With an HSA, you can decide how much you want to contribute, up to annual limits set by the IRS. If you have an HSA through your employer, you can set up automatic account contributions from your paycheck.
Your contribution to your HSA depends on your personal financial situation. Ideally, you’d contribute the maximum allowed each year by the IRS, says Juli Erhart-Graves, certified financial planner and president of Worley Erhart-Graves in Indianapolis.
In 2022, the maximum allowed contribution to the HSA is $3,650 for individuals and $7,300 for families. If you are 55 or older at the end of the tax year, you can contribute an additional $1,000.
If you can’t afford to contribute the maximum, try to contribute the amount you expect to pay for eligible medical expenses for the year. “Since you have to pay the medical bills anyway, send them through the HSA so you don’t have to pay taxes on those amounts,” says Erhart-Graves.
Benefits of an HSA
An HSA has a number of advantages, tax advantages being among the most important:
- Contributions to an HSA are tax deductible, or pre-tax if made through payroll deduction. This means that they are not included in your annual gross income and are not subject to federal income tax.
- If you invest in the HSA, the earnings are tax exempt.
- Withdrawals are tax-free as long as they are used to cover eligible medical expenses.
- You can use HSA funds now and during your retirement years.
- You, an employer, a relative, or others can contribute to your HSA.
- There are no time constraints for spending the funds. If you have money left in your HSA at the end of the year, it is carried over for you to use the following year.
- If you can afford to pay for your medical expenses out of pocket each year, you can still make the maximum contribution to your HSA and build the account for future use. “It’s important that you have the receipts for a distribution, but it gives you a tax-free distribution, which can be very helpful in retirement,” Erhart-Graves says.
- Your HSA is portable, so even if you change employers or insurance companies, you can still use the funds for eligible medical expenses.
- The list of medical expenses eligible for HSA expenses is vast – everything from glasses and hearing aids to bandages and birth control pills.
- HSAs can be invested in mutual funds, stocks and other investment products.
- HSAs pass to your designated beneficiary upon your death. A spouse can inherit the money tax-free.
The tax benefits are the best thing about an HSA, which is more tax-efficient than a 401(k). HSAs have a triple tax advantage:
- Contributions made to an HSA are not subject to federal taxes.
- Interest earned by investing in an HSA is not taxable.
- Distributions from an HSA are tax-exempt, as long as they were used to pay eligible medical expenses.
Disadvantages of an HSA
Despite its great tax advantages, an HSA does have some disadvantages.
- It can only be spent on eligible medical expenses.
- If the HSA funds are used for anything other than eligible medical expenses, you will have to pay taxes on that money, plus a 20% tax penalty. After age 65, you will owe the taxes, but not the penalty.
- Some HSA providers charge account fees, such as a monthly fee or a per-transaction fee. You may be charged for account overdrafts or deposits that are not cleared. Ask your HSA dealer for a complete fee schedule.
- You must be enrolled in a high-deductible health plan to qualify for an HSA.
What happens to an HSA if you change jobs
HSAs are portable accounts. So if you change insurance, change jobs, or retire, you’ll still have access to your HSA. “It’s yours. You can move it to another bank or custodian if you want,” Erhart-Graves says.
You can also continue to contribute as long as you meet federal eligibility rules.
If you no longer have medical insurance that qualifies for an HSA, your existing HSA stays there until you use it, move it, or invest it, Erhart-Graves says.
How to invest for an HSA
Some or all of the funds in health savings accounts can be invested in mutual funds, stocks, bonds and other investment products. This is a tax-free way to increase your HSA to pay for medical expenses in retirement.
But investing in risky products can mean that your money won’t be there when you need it to pay for your health care. Luckily, you can also put your money in safe but low-yielding investments, like a money market fund.
The choice of HSA investment tools differs between plan depositories. Some HSAs are just savings accounts that don’t pay much interest. Shop around for a plan with quality investment options and low costs.
Remember that FDIC-insured savings accounts are protected up to $250,000, but stocks and other investments do not have this protection.
HSA vs Flexible Spending Account (FSA)
HSAs and FSAs have similarities and differences. Here’s a comparison of the two to help you decide which option is best for your needs and goals.
- Contributions to HSAs and FSAs are tax-exempt, subject to contribution limits.
- Distributions from HSAs and FSAs are tax-free as long as the money is spent on qualifying medical expenses.
- HSAs have more growth potential than FSAs because they can be invested and the profits are tax-free.
- You must have a high-deductible health plan to qualify for an HSA. You can have an FSA with a traditional health plan.
- Contribution limits for HSAs are higher than those for FSAs.
- Unspent HSA funds roll over year after year. If you don’t spend your FSA, you entrust those funds to your employer, although some employers have grace periods or allow you to carry over a certain amount.
- An HSA is transferable if you change jobs, insurance plans, or retire. An FSA is not.
- You can change the amount of your contribution to an HSA at any time, but FSA contribution decisions are generally limited to the annual enrollment period.
- Both accounts often come with a debit card to make it easier to pay and track medical expenses.
At the end of the line
If you have a high-deductible health plan, opening a health savings account is a very smart financial decision. The tax benefits are significant and it’s a great way to save money for health care costs in retirement.