Health savings accounts (HSAs) are specialized savings accounts you can use for current or future healthcare expenses. Your contributions are tax-free.
HSAs were created in 2003 so that people with high deductible health plans (HDHPs) could receive tax savings on their medical care. Today, HSAs are a popular savings and medical expense option. You also need an HDHP to use an HSA.
Read on to learn more about this healthcare payment option.
An HSA is an account you can use to save for your healthcare expenses. You can set aside pretax money in your HSA and then use it to pay for medical expenses such as deductibles or copayments.
“You can think about an HSA account as a way to get a significant discount on your medical costs,” Yulia Petrovsky, a financial planner with Modern Financial Planning, told Healthline.
“It allows you to put aside funds to pay for qualified medical expenses, up to an annual limit. Those funds avoid all taxes, except in California and New Jersey, where state income taxes are still applied.”
An HSA allows you to save money on your medical expenses. You can set aside money from your paycheck on a pretax basis and use that money toward your healthcare costs.
You can contribute money directly from your paycheck or contribute on your own at any time. Money contributed from your paycheck will come out before taxes are taken out. Any money you contribute on your own can be counted as a tax deduction when you file your taxes.
However, there are a few rules you need to know:
- You need to have an HDHP with a minimum deductible of $1,400 for an individual plan or $2,800 for a family plan.
- You can contribute $3,600 per year for an individual plan or $7,200 per year for a family plan.
- Contribution limits include any funds your employer contributes to your HSA.
The minimum deductible and maximum contribution levels are set by the IRS each year. These limits apply to everyone and aren’t affected by your job status or income level. The only exception to the limit is for people over 55, who are allowed to contribute additional funds.
“Annual contribution limits are increased by $1,000 for those over 55. If two spouses have separate HSA accounts and both are over 55, total additional contribution could be up to $2,000,“ Petrovsky said.
Any money you don’t spend will stay in the account. This makes HSAs distinct from flexible spending accounts (FSAs). When you have an FSA, you lose any money you don’t use by the deadline, which is usually the end of the year.
The money you put into an HSA will remain in your account and available for you to use. You’ll be able to access these funds even when you no longer have an HDHP. This can have several advantages.
One great example is Medicare. You generally can’t use your HSA to pay the premiums on your health insurance, but you can use it to pay Medicare premiums. So if you contributed to an HSA while you were working, you could then use those funds to pay your Medicare premiums after retirement.
HSAs and investments
Some HSAs are both savings and investment accounts. When your HSA is an investment account, you can not only set aside tax-free money but also earn additional funds. Plus, the funds you earn from your investments are tax-free. Other accounts allow you earn interest on the funds in your HSA. Just like investment earnings, any interest earned will be tax-free.
“If your HSA is investable, the earnings are also tax-free, as long as all withdrawals are used for qualified medical expenses. HSA accounts are the ‘triple tax advantage’ accounts — contributions of untaxed money, no tax on earnings, and no tax on qualified withdrawals. A trifecta of tax savings,” Petrovsky told Healthline.
High deductible health plans are plans that offer lower premiums in exchange for a higher deductible. Generally, high deductible plans will pay for preventive care such as vaccines, health screenings, and some medications, before you meet the deductible.
For any other services, all costs will fall to you until you meet the deductible. This makes HDHPs very popular with young and healthy people who don’t want to pay high premiums and have very few medical expenses.
HSAs are designed to work with HDHPs. You can get an HDHP from your employer or from the Health Insurance Marketplace. HDHPs in the Health Insurance Marketplace will be marked as high deductible plans, so you won’t need to figure out on your own if a plan meets the requirements.
Once you have an HDHP, you’ll need to make sure you also:
- don’t have any other health insurance plans
- aren’t eligible for Medicare
- can’t be claimed as a dependent on someone else’s taxes
There are also set rules about how you can use your HSA funds. Withdrawals aren’t taxed, but you’ll need to make them to pay for qualified medical expenses. These expenses include:
- your insurance deductible
- physician visit copayments
- dental care
- vision care
- prescription medications
- hospital copayments or coinsurance
- physical therapy
- lab work
- imaging tests such as MRIs or X-rays
- mobility equipment such as walkers or wheelchairs
- accessibility equipment for your home
- home healthcare
- nursing facility care
HSAs have some significant advantages. You can set aside tax-free money that you can use to pay medical expenses even when you’re no longer enrolled in an HDHP. Your HSA is yours, and you can’t lose it by changing health plans or jobs. There’s also no set time you need to start making withdrawals.
You can keep money in your HSA for as long as you want. Plus, your account can grow with tax-free investment earnings, and any qualified withdrawals you make are also tax-free.
“The income tax savings aspect of HSAs is the main advantage, followed by the fact that those funds are yours to keep, even when you are no longer covered by a qualified high deductible health plan, unlike FSA plans that work on a ‘use it or lose it’ basis,” Petrovsky explained.
“HSA funds do not have an expiration date whatsoever. In addition, you don’t have to have earned income to be eligible for contributions.”
HSAs are a great fit for many people, but they’re not right for everyone. The biggest drawback to an HSA is that you need to have an HDHP. Unfortunately, HDHPs aren’t necessarily a good choice for people who are managing certain health conditions or chronic illnesses.
“You do need to be covered by a qualified high deductible health insurance plan, and for somebody with, for example, a chronic illness that requires expensive care, the tax savings might not outweigh the high out-of-pocket medical costs associated with a high deductible plan,” Petrovsky told Healthline.
There are few other possible downsides to an HSA to keep in mind:
- Making contributions to the account can strain your budget.
- An unexpected illness could wipe out the balance of your HSA.
- HDHPs can cause people to avoid seeking needed medical care.
- The money can only be used tax-free on medical expenses. You’ll pay taxes if you use your HSA money for anything else.
HSAs are a great fit for healthy people looking for a savings plan and a health insurance plan. If you were considering starting a savings plan such as a 401(k) or an IRA, an HSA might be a better bet.
“If you are eligible to make an HSA contribution and have the means, funding your HSA is a no-brainer,” Petrovsky explained. “If you have to pick between funding your IRA and an investable HSA, going for the HSA is a wise choice, because HSA is the only triple-tax-advantage account out there.”
You’ll still be able to get vaccines and other preventive care covered, and you’ll have money saved if you do need to seek other medical care. You can look at your current budget and medical expenses. If medical expenses are currently taking up only a small portion of your budget, an HSA could be a smart choice.
People nearing retirement might also be a good fit for an HSA. Remember that if you’re over 55, you can contribute an additional $1,000 each year. You won’t be able to make new contributions once you’re eligible for Medicare, but you will be able to spend your HSA funds on Medicare premiums and copayments.
Your employer can contribute to your HSA. This is a popular workplace benefit. It’s common in companies that offer HDHPs as a primary health insurance option.
Contributions your employer makes still count toward your yearly maximum contribution. You can keep track of your employer contributions on your paychecks and your yearly W-2. If you’re still under the limit, you can make contributions for the previous year while you file your taxes.
“That amount is then stated as employer contributions on Form 8889 of your tax return, allowing you to calculate what additional amount can still be contributed for that tax year,” said Petrovsky. “You can make any additional contributions by the due date of your tax return, usually April 15.”
HSAs are accounts you can use to set aside tax-free money for medical expenses. The money you contribute often earns interest or investment returns.
These earnings are also tax-free. You can keep money in your HSA for as long as you need to. You’ll need a high deductible health plan to use an HSA.
HSAs may be a good option for generally healthy people with few medical expenses.