Healthy Choice: How an HSA Can Save You

A Health Savings Account (HSA) is a type of savings account that enables you to set aside pre-taxed funds to pay for qualified medical expenses. Using untaxed dollars in an HSA to pay expenses such as deductibles, drug prescriptions, copays, some dental work, glasses and vision-related care, and some other expenses can lower your overall health care costs. HSA funds generally may not be used to pay insurance premiums, however.

The bipartisan Medicare Prescription Drug, Improvement, and Modernization Act, which was signed into law by President George W. Bush in January 2004, established HSAs. Like individual retirement accounts, HSAs were designed as a long-term savings vehicle and a way to defray medical expenses.

An HSA allows you to make pre-tax contributions and take tax-free withdrawals to pay for covered care. HSA funds roll over year to year if you don’t spend them. An HSA may earn interest, which is not taxable. The money in an HSA can be invested and grow over time. At age 65, you can withdraw your HSA funds for non-qualified expenses at any time; although, they are subject to regular income tax. You can avoid paying taxes by continuing to use the funds for qualified medical expenses.

Another option is a Flexible Spending Account (FSA), sometimes called a “flexible spending arrangement,” into which you can put money to pay for certain out-of-pocket health care costs.

Both an HSA and an FSA will allow you to pay for medical care with pre-tax dollars, which reduces the cost. With healthcare accounting for 8.1% of Americans’ average monthly expenses, these tax shelters are important financial tools. The main difference between the two is that an individual controls an HSA, while FSAs are owned by an employer.

While you can make pre-tax contributions and take tax-free withdrawals from an FSA, FSA accounts can only be opened by employers. These accounts serve as a short-term savings account rather than an investment account; the money in an FSA cannot be invested. You must decide at the start of the year how much to contribute, and the money is lost if not used for medical care in the year it is contributed or shortly thereafter.

You may contribute to an HSA only if you have a High Deductible Health Plan (HDHP), which is a health plan that generally covers only preventive services before the deductible. For plan year 2023, the minimum deductible for an HDHP is $1,500 for an individual and $3,000 for a family.

For 2023, if you have an HDHP, you can contribute up to $3,850 into an HSA for self-only coverage and up to $7,750 for family coverage. Individuals aged 55 or older by the end of the tax year can make catch-up contributions of an additional $1,000 to their HSAs. The annual limits on contributions apply to the total of the amounts contributed by both the employer and the employee.

An HSA can also be opened at certain financial institutions. Contributions can only be made in cash at financial institutions, while employer-sponsored plans can be funded by the employee and the employer. Any other person, such as a family member, can also contribute to the HSA of an eligible individual. Self-employed or unemployed individuals may also contribute to an HSA, provided they meet the eligibility requirements.

Individuals who enroll in Medicare can no longer contribute to an HSA as of the first month of enrollment. But they can receive tax-free distributions for qualified medical expenses.

Advantages and Disadvantages of an HSA

HSAs have several advantages as well as some drawbacks, which each depend entirely on your personal and financial situations.

Advantages

Employer contributions and an individual’s contributions by payroll deduction to an HSA are excluded from the employee’s taxable income. An individual’s direct contributions to an HSA are 100% tax-deductible from the employee’s income. Earnings in the account are also tax-free. However, excess contributions made to an HSA incur a 6% tax and are not tax-deductible.

Your HSA belongs to you, so you can use the money in your account to pay for qualified health care expenses throughout your life—including retirement. There is no time limit on when to spend your HSA funds. Even if you change health plans, switch jobs, or retire, your HSA goes with you. It’s yours for life, and the funds never expire.

Distributions from an HSA are tax-free, provided the funds are used for qualified medical expenses as outlined by the IRS. Distributions used for medical expenses that are covered under the HDHP plan are included in determining if the HDHP’s deductible has been met. Sometimes, you can use your HSA to pay for qualified medical expenses for your spouse and dependents, even if your high-deductible health plan doesn’t cover them.

You can also use the money in your HSA to invest in stocks and other securities, potentially allowing for higher returns over time.

Disadvantages

The most obvious key drawback is that you need to be a good candidate for an HDHP. You must have a high-deductible plan and lower insurance premiums or be affluent enough to afford the high deductibles and benefit from the tax advantages.

Individuals who fund their own HSAs, whether through payroll deductions or directly, should be financially capable of setting aside an amount that would cover a substantial portion of the HDHP’s deductibles. Individuals without enough spare cash to set aside in an HSA may find the high deductible amount burdensome.

HSAs also come with filing requirements regarding contributions, specific rules on withdrawals, distribution reporting, and a record-keeping burden that may be difficult to maintain.

Before you turn 65 years old, any HSA funds you withdraw to pay for nonmedical expenses are considered taxable income. The IRS also levies a 20% penalty. Expenses can be audited by the IRS, so you should keep receipts for all payments made with HSA funds.

Conclusion: Healthy, Wealthy, and Wise

All in all, HSAs are one of the best, tax-advantaged savings, and investment tools available under the U.S. tax code. They are often referred to as triple tax-advantaged because contributions are not subject to tax, the money can be invested and grow tax-free, and withdrawals are not taxed if you use them for qualified medical expenses.

As a person ages, medical expenses tend to increase, particularly when reaching retirement age and beyond. Starting an HSA at an early age, if you qualify, and allowing it to accumulate over a long period of time, can contribute greatly to securing your financial future.

Visit https://www.healthcare.gov/high-deductible-health-plan/  to learn more about HSAs.

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