What is a health savings account? How does it work? Can an HSA help you cover health care costs and save money?
Many workers are able to reduce their health insurance premiums by signing up for a high-deductible health insurance plan and pairing it with a health savings account. HSAs provide a triple tax benefit: You don’t have to pay income tax on your contributions, the money in the account grows without being taxed and the funds can be withdrawn tax-free when used to pay for medical expenses.
Unlike a flexible spending account, which often requires you to use your funds within 15 months or so, the money in your HSA can be rolled over from year to year and be used for future medical care needs, even during retirement. Here’s how to decide if a health savings account is right for you.
What is an HSA? HSAs allow you to regularly designate funds for upcoming medical needs. “An HSA is a personal savings account for health expenses,” says Shobin Uralil, co-founder and chief operating officer of HSA provider Lively. To be eligible for an HSA, you must be enrolled in a high-deductible health care plan. In 2021, an HSA-eligible HDHP is defined as a plan with a deductible that is at least $1,400 for an individual or $2,800 for a family. Once you have an HSA, your employer can contribute to the account as well.
In 2021, the maximum amount that can be put into an HSA is set at $3,600 for an individual and employer. The maximum worker-employer contribution for family coverage is $7,200. The annual limit on HSA contributions is about a 1.5% increase from this year. You can use the money in the HSA to pay for qualifying medical expenses such as deductibles and copayments or save for future health costs.
How is an HSA different from an FSA? There are some key differences between an HSA and a flexible spending account, or FSA, Uralil says. An HSA is owned by the individual, regardless of who he or she is employed by. FSAs are offered by certain employers, and those accounts can’t be taken by an individual if he or she changes jobs. FSAs typically have time limits to use or lose the funds you contribute. “You can’t roll over FSA funds year after year until you retire,” Uralil says. It’s also important to know that you can’t contribute to an HSA if you are putting money into an FSA. Consult with your benefits representative if you have further questions about the differences between an HSA and an FSA.
What can you use an HSA for? It’s important to know what you can and can’t use HSA funds for. “Generally speaking, if you are employed and younger than 65, you can’t use HSA funds to pay for health insurance premiums,” says J.D. Piro, leader of the health law consulting group for Aon, a multi-national firm that sells health insurance plans and other products. He’s co-host of a podcast on health care law.
There are few exceptions. HSAs can be used to reimburse you for premiums for:
— Long-term care insurance, subject to certain limits.
— Health care continuation coverage, such as COBRA.
— Health care coverage while receiving federal or state unemployment compensation.
— Medicare and other health care coverage if you’re at least 65, except for premiums for a Medicare supplemental policy.
What medical costs can HSA funds be used for? If you have a medical condition that requires ongoing treatment, make sure money in an HSA can be applied to your particular needs. “The good news is there’s a very broad range of things you can pay for tax-free with HSA funds,” says says Anthony Lopez, vice president of sales at eHealth, a private online health insurance exchange.
Those goods and services include:
— Prescription drugs.
— Costs associated with guide dogs and other service animals.
— Dental and vision care costs.
— Chiropractic care.
— In vitro fertilization.
Decide if a high-deductible health care plan is right for you. If you’re thinking about opening an HSA, you’ll want to evaluate your current health plan. If your employer offers both high-deductible and low-deductible health plans, compare the costs associated with each option. Look at what you might pay in monthly premiums, a deductible and copayments, says Taylor Hammons, head of retirement plans at Kestra Financial in Austin, Texas. “Since the HSA is only available with a HDHP, the monthly premiums are generally lower than the premiums associated with a low-deductible health plan,” Hammons says.
HSA age limits. “Anyone younger than age 65 can use an HSA,” says Anthony Lopez, vice president of sales at eHealth, a private online health insurance exchange. After age 65, you can continue to withdraw funds for medical expenses but you won’t be able to make more contributions. If you’re a younger adult and don’t visit the doctor that often, you might benefit from being able to save a greater amount in an HSA. “Older adults — especially those who are healthy and rarely see the doctor — often like HSAs because they’re more likely to have the money to fully fund them,” Lopez says. There are also special benefits for those approaching retirement: Individuals who are 55 or older can deposit an extra $1,000 into the account each year.
Reduce taxes with an HSA. One of the key benefits of an HSA lies in the triple tax benefit associated with this type of account. “Contributions are typically made with pretax dollars,” Hammons says. In addition, when you use the money in the account to pay for qualified health care expenses, you won’t have to pay taxes on the withdrawals in most states. If the money in the account is invested and grows, you also don’t have to worry about tax-related expenses on the investment gains. “Any earnings on the assets in the account are tax-free,” Hammons says.
Save for future medical costs with an HSA. There’s no time limit on the assets you accumulate in an HSA. “If there is a balance left in the HSA at the end of the year, it rolls over to the next year for future use,” Hammons says. This means that any money you put into the account and don’t take out has the potential to grow. Over time, the amount in the account could increase and be used to fund later medical expenses like long-term care.
Take care to avoid HSA penalties. HSAs are 100% tax-free if used for qualified medical expenses. If HSA withdraws are used for non-qualified expenses, account holders can incur a 20% penalty plus income taxes, Uralil says. These expenses are regulated by the IRS, and it’s up to the account holders to stay compliant — not only this year but from the time you opened your HSA. There is one exception. As a birthday present from the IRS, you can use your HSA money for anything when you turn 65, not just qualified medical expenses. You just pay ordinary income taxes at that time — no penalty. In that sense, after you turn 65, you can use your HSA funds just like a 401(k) or an IRA.
How to invest your HSA. It’s important to keep in mind that the funds you put into the account remains yours, even if you switch jobs. That means you can incorporate your HSA into long-term savings plans.
You can place the funds in your HSA in various investment options, including:
— Mutual funds.
— Exchange-traded funds.
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Update 05/27/21: This article was previously published and has been updated with new information.