What is a Health Savings Account?
A health savings account, or HSA, is a supplementary savings account that can be used to pay for certain healthcare expenses. HSAs are a popular vehicle to save for medical expenses, largely due to the three tax benefits they offer. First, contributions can be made with pre-tax dollars which are exempt from income tax. Second, interest and gains within the HSA are also untaxed. Finally, withdrawals used for qualified medical expenses are tax-free, even before age 65.
HSAs are subject to an annual contribution limit. For 2020, the limit is $3,550 for individuals and $7,100 for families, with an additional $1,000 for anyone age-55 and older. Contributions to HSAs are separate from 401(k) contributions, meaning you can max out contributions for both in any given year. If you don’t have an employer sponsored HSA, you can still open one through a bank or other financial institution. Contributions made in these accounts can also be deducted from your gross income, making them tax-deductible.
Who qualifies for HSAs?
In order to be eligible for an HSA, you must be enrolled in a high-deductible health plan. These plans are redefined each year by the IRS, outlining the minimum deductible they must have as well as the maximum amount the plan-holder can spend out of pocket. For 2020, a high-deductible health plan is a plan with a deductible of at least $1,400 for an individual or $2,800 for a family, and yearly out-of-pocket expenses cannot exceed $6,900 for an individual or $13,800 for a family.
What can I pay for using an HSA?
HSAs can be used to pay for any qualified medical expense. This broad term includes most medical expenses you’re likely to incur, as well as some things you may not expect to be covered, such as chiropractors or acupuncture. More information on which expenses qualify can be found at www.irs.gov/publications/p502. You aren’t limited to personal medical expenses, either. You can use HSA funds to cover expenses for yourself, your spouse, as well as any tax dependents. It’s worth noting that HSA funds typically cannot be used for insurance premiums.
Other HSA benefits
HSAs offer a number of unique benefits that other similar accounts, such as flexible spending accounts, do not. Any money left in your HSA at the end of the year rolls over to the next year, and money in your HSA remains available even if you change insurance plans, change employers, or retire. You can also invest the money in your HSA. Since the gains aren’t taxable and funds rollover from year to year, it’s possible to use your HSA as an investment account of sorts. You can no longer contribute to an HSA once you enroll in Medicare, but any funds left in your account can still be used. Qualified expenses can be reimbursed at any time, not just at the time they are incurred. Because of this, some HSA owners choose to wait until retirement before submitting their expenses. This allows them to keep more money invested in their HSA to grow tax-free and use their reimbursements to supplement their retirement income.
Drawbacks of an HSA
Though they offer many benefits, HSAs are not for everyone. First off, high-deductible health plans are not right for everyone. Though they offer lower premiums than other types of plans, the high deductible can be difficult to pay for if unexpected medical expenses arise. You must also keep receipts for all medical transactions to prove your withdrawals were used for qualified medical expenses. If you make withdrawals for non-qualified expenses before age 65, you’ll owe taxes on the money plus a 20% penalty. After you turn 65, you’ll still owe taxes but won’t incur the penalty. Some HSAs charge maintenance fees or a per-transaction fee. Though typically low, the fees can affect your bottom line, especially if they aren’t thoughtfully managed.