My employer offers two health insurance plans. One provides access to a Flexible Spending Account, while the other provides access to a Health Savings Account. What is a Health Savings Account? Does it provide enough value to outweigh a higher deductible on health insurance for my family?
A Health Savings Account(HSA) is a tax-deferred account defined in 2004 to help workers save for future medical needs. Providing a myriad of financial benefits, including tax-free contributions/growth/qualified distributions, potential company matching, and the option to invest a portion of its funds, an HSA is one of the most powerful savings tools available to support your future retirement.
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Who Can Contribute to a Health Savings Account?
There are rules around a Health Savings account which govern who is eligible to open one and contribute. To contribute to an HSA, an individual must:
- Be covered by a High deductible Health Insurance plan
- Not be enrolled in Medicare
- Not be claimed as a dependent on another’s tax return.
To qualify for an HSA, your High Deductible Health Insurance plan may not:
- Have an annual deductible below $1300 for individuals or $2600 for families
- Provide any payout or benefits before you have met the deducible in full
- Plans may provide benefits for qualified preventative care before you meet the deducible.
Caution: if your plan offers different deductible and out-of-pocket limits for a covered individual and the covered family, if either fails to meet these requirements, you will be ineligible for an HSA.
Health Savings Account Mistakes to Avoid
Some of the common mistakes you can avoid to place yourself ahead of the curve are:
Not Participating
A joint study by Devenir and The HSA Council found that:
While HSA participation is on the rise, there are currently only around 31 million HSA accounts in the US.
Leaving the Entirety of your account balance in cash
The vast majority of HSAs are invested entirely in cash. Upon reaching a minimum balance, additional funds are likely eligible to be invested in higher performing securities. This single action is likely to grow your account more than your total contributions by the time you retire. Investments are up to the employee to direct, so take a look around your HSA account site and familiarize yourself with your options.
Using it to pay for medical expenses that you can easily cover out of pocket
Paying for day-to-day medical expenses that you can fit within your budget to cover out of pocket allows the money in your HSA to continue to grow. You can reimburse the prior year’s qualified expenses at any time, so if you pay out-of-pocket now and find yourself in a tight spot in future years, you can always reimburse yourself at that time to lighten the load.
Withdrawing funds for non-medical expenses
Pulling money from your HSA prior to the age of 65 will be a taxable event, and you will pay an additional 20% on non-qualified withdrawals.
Not paying attention to fees
Administration and similar fees can quickly eat away at your progress. While the majority of options available within an HSA are likely to be passively managed and low cost, make sure you take them into consideration when deciding on the best investments for you.
What Can You Use the Money in Your HSA For?
Money in your Health Savings account can be used tax-free, at any time, for a wide gamut of medical expenses. Eligible expenses can fall within the realm of medical, dental, or vision, and you can find a comprehensive list on the IRS website. You can make eligible withdrawals on your own behalf or for eligible dependents.
After the age of 65, you can withdraw money for any reason without penalty, but will be subject to tax if the expense is not a qualified medical expense.
How Much Can I Contribute to an HSA?
As of 2022, individuals can contribute $3,600 annually, while those enrolled in a family health plan can contribute $7,200 annually.
Will My Employer Match My Contributions to an HSA?
Employers may (but are not required to) offer contributions to employees’ HSA accounts. If your employer makes contributions on your behalf, the amount applies to the annual contribution limit, so you will need to adjust your withholdings accordingly.
Can I Invest the Money in My HSA?
Typically yes! While most accounts will require a portion of your account to remain in cash once your account exceeds that amount, additional funds may well be eligible to be invested. You will direct your account’s investments, so log into your HSA provider’s website and review your options.
What’s the Difference Between an HSA and an FSA?
A flexible spending account is a sibling of an HSA made available to individuals covered by low deductible health insurance plans. While both account types allow employees to leverage pre-tax income for medical expenses, they are distinct. Compared to an FSA, an HSA:
- Has More stringent qualifications
- While an HSA is only available to those taking part in a qualified High Deductible Health Plan, an FSA is available to most full-time employees.
- Is owned and overseen by the employee
- An FSA is not available to individuals who are self-employed or not employed.
- In an FSA, a maximum of $500 can roll over year over year, while an HSA sees its entire balance carry over and grow.
- An employer can allow the total account balance to roll over into a new year for up to two months. Check with your benefits department to ensure you are aware of the date your funds expire.
- Employees are likely to lose an FSA upon a change in employer while an HSA goes with the employee.
- May allow account holders to invest some portion of funds their funds.
- Qualified HSA plans may allow funds to be invested, allowing participants to leverage the stock market to power their accounts.
- Allows greater annual contributions
- Annual contribution limits for an HSA are ~30% higher, allowing more of your income to grow tax free towards retirement.
- Is far more likely to include an employer contribution
- Employer matches to an FSA are rare.
What Are the Tax Advantages of an HSA?
Contributions to your HSA lower your taxable income.
The IRS does not consider employer contributions income. Contributions made via payroll deduct are pretax, while contributions made with after-tax funds are tax-deductible. Individuals may claim this tax deduction even in years where they take the standard deduction.
HSA Accounts Grow Tax-Free
Accumulation, dividends, and interest are not taxable events when housed within an HSA.
Qualified Withdrawals Are Tax-Free
The money is available when you need it most without hitting you with a tax bill.
What Are the Pros and Cons of Health Savings Accounts?
Pros – Why You Should Have an HSA:
Triple Tax Advantage
Contributions to HSAs are pre-tax or tax-deductible.
You can invest the balance and watch it grow tax-free while compounding in value.
You can reimburse yourself for qualified expenses tax-free.
No Mandatory Withdrawals
You are not required to take distributions at any age, so your account continues to grow until you need it.
Possible Employer Contributions
Your employer may offer an annual contribution to your HSA. This money counts towards your maximum contribution amount for the year, but it is essentially free money. Check with your HR department to see if your employer offers this incentive.
Portable and Permanent
The entire account carries over from year to year and stays with you through life and employment changes.
Cons – Why an HSA May Not be Right For You:
An HSA Requires You to Elect a High Deductible Health Insurance Plan.
Your health and the health of those you love is a difficult thing to predict and not something easily gambled upon. If you know that you have medical needs in your family, the coverage afforded by more comprehensive health insurance may be worth the upfront cost and loss of an HSA.
You May Need the Money Contributed to Your HSA for Non-Medical Expenses
Withdrawing money from your HSA account before the age of 65 can be expensive if the money is for anything other than a qualified medical expense. Not only will the withdrawal be a taxable event, but it will also be subject to an additional 20% tax. If you do not already have an emergency savings, you might prioritize creating one before funding an HSA.
Should You Take Advantage of an HSA? Does an HSA make High Deductible Health Insurance Worthwhile?
The requirement of a High Deductible Health Plan makes the decision of an HSA extremely personal. While it increases the potential out-of-pocket cost, it ensures that your annual expense more closely aligns with your actual healthcare needs.
Insurance of any kind seeks to find this balance. When your expenses are low, you pay more into insurance to help cover the possibility of future emergencies. If these emergencies never arise, there is a lost opportunity balanced out by a provided peace of mind. It’s a heavily incentivized calculated gamble on an aspect of life that is difficult to gamble upon.
The age and health of your entire household will help guide your decision. Peace of mind also has value and the more expensive but safe route is not inherently the wrong choice.
I am (fairly) young, single, and healthy. Given my situation, I currently take advantage of an HSA. Any change in my family situation or health could cause me to course appropriately. If I switch to a low deductible plan, I will no longer be able to contribute additional money into my HSA, but the money I have built up will go along with me.
A combined approach is perhaps the best of both worlds, building up a balance in one’s HSA while your age and health allows, before switching to a more comprehensive plan in later years as your health becomes more unpredictable.
Health Savings Account Rules- What Happens to My HSA When I Die?
If you leave your HSA to your spouse, it is not a taxable event. Anyone else will have to pay taxes on the balance of the account at the time of inheritance.