What is a health savings account?

A health savings account, or HSA, is a tax-advantaged savings account for paying medical expenses that is available to consumers with high-deductible health insurance plans. Unlike a flexible spending account, an HSA has no deadline for spending funds and money can be held for years. It can even be stashed away for health care costs in retirement.

Here’s what else you need to know about health savings accounts.

How an HSA works

An HSA offers a triple tax advantage for Americans saving for healthcare:

  • Contributions to an HSA are tax-deductible

  • Earnings on an HSA are tax-free if money is used for qualified healthcare expenses

  • Withdrawals from an HSA are tax-free if used for qualified healthcare expenses

The tax advantages of an HSA are available only if it is used to pay qualified out-of-pocket medical expenses such as payments for doctor’s office visits, prescriptions, ambulance services, eyeglasses and more. The IRS has a list of qualifying medical expenses. Money that is used for non-qualified expenses is subject to a 20 percent penalty in addition to taxes on the withdrawal.

The federal government sets the ceilings for out-of-pocket medical expenses for high-deductible healthcare plans. For 2023, the most an insured individual can be required to pay out of pocket in a year is $7,500; the limit is $15,000 for a family. Once the insured party has met the out-of-pocket maximum, the insurance company must cover the rest.

Other features of an HSA include the following:

  • HSAs generally come with a debit card or checks to make paying for medical expenses easy and straightforward.

  • HSA funds roll over year after year, and the HSA does not have a required minimum distribution or withdrawal deadline. Any money you put into your HSA stays there until you use it.

  • HSAs are portable. If you change jobs or health insurance plans, your HSA goes with you.

If you’re 65 or older and enrolled in Medicare, you can no longer make contributions to an HSA, but you can still use the money you’ve built up in the account to pay out-of-pocket medical expenses.

Plus, some people use an HSA as a retirement account. Once you turn 65, any money in the account is no longer subject to the 20 percent bonus penalty. Rather, withdrawals are subject only to ordinary income taxes. In other words, after age 65, an HSA functions like a traditional IRA, but perhaps a bit better because it does not have a required minimum distribution.

How to get an HSA

To qualify for an HSA, you must be enrolled in a high-deductible health insurance plan and have no other health insurance. You cannot be claimed as a dependent on someone else’s tax return nor eligible for Medicare.

The IRS sets the thresholds for what is considered a high-deductible health plan. For 2023, a qualifying insurance plan has a deductible of at least $1,500 for an individual or $3,000 for a family. Not all plans with a high deductible are eligible, so when shopping for an HSA look for plans that say “HSA-eligible.”

Your employer may offer an HSA, but many financial institutions offer these accounts, too. BMO Harris Bank and Bank of America offer HSAs, for example, as did Fidelity Investments and Charles Schwab. You must fill out an application and provide basic information, such as your Social Security number, date of birth, physical address, phone number and a valid email address.

You can use HealthCare.gov to find HSA-eligible plans and websites such as HSASearch to compare HSA providers.

HSA contribution limits

With an HSA, you can decide how much you want to contribute, up to the annual limits set by the IRS. If you have an HSA through your employer, you can set up automatic contributions to the account from your paycheck.

In 2023, the maximum HSA contribution is $3,850 for individuals and $7,700 for families. If you are 55 or older at the end of the tax year, you can contribute an additional $1,000.

How much you should contribute to your HSA depends on your personal financial situation. Ideally, you would contribute the maximum allowed each year by the IRS, says Juli Erhart-Graves, certified financial planner and president of Worley Erhart-Graves in Indianapolis.

If you can’t afford to contribute the maximum, try to contribute the amount you expect to pay for qualified medical expenses for the year. “Since you have to pay the medical expenses anyway, send them through the HSA so you don’t have to pay taxes on those amounts,” Erhart-Graves says.

Advantages of an HSA

There are a number of benefits to an HSA, with tax perks being among the most significant:

  • Contributions to an HSA are tax-deductible, or pre-tax, meaning they are not included in your annual gross income and are not subject to federal income taxes.

  • If you invest money in the HSA, earnings are tax-free as long as any withdrawal is used for qualified healthcare expenses.

  • Withdrawals are tax-free as long as they’re used to cover qualified medical expenses.

  • You can use HSA funds now and in retirement.

  • You, an employer, a relative or others can contribute to your HSA.

  • There are no time constraints for spending the funds. If you have money left in your HSA at the end of the year, it rolls over so you can use it the following year.

  • An HSA functions much like a traditional IRA once you turn 65, with withdrawals being taxed at ordinary income rates and without the usual 20 percent bonus penalty.

  • If you can afford to pay out of pocket for your medical expenses each year, you can still make the maximum contribution to your HSA and build up the account for use in the future. “It’s important that you have the receipts to match up to a distribution, but this gives you a tax-free distribution, which can be very helpful in retirement years,” Erhart-Graves says.

  • Your HSA is portable, so even if you change employers or insurance companies, you can still use the funds for qualified medical expenses.

  • The list of medical expenses that qualify for HSA spending is extensive — everything from eyeglasses and hearing aids to bandages and birth control pills.

  • HSAs can be invested in potentially high-return assets such as mutual funds, stocks and other investment products.

  • HSAs are passed on to your designated beneficiary when you die.

Tax advantages of an HSA

The tax benefits are the best thing about an HSA, which offers a threefold tax benefit:

  • Contributions made to an HSA aren’t subject to federal taxes.

  • Earnings in an HSA aren’t taxable, as long as any withdrawals are used for qualified medical expenses.

  • Distributions from an HSA are tax-free, as long as they are used to pay for qualifying medical expenses.

Disadvantages of an HSA

Despite its big tax advantages, an HSA does have a few drawbacks.

  • It can only be spent on qualifying medical expenses.

  • If HSA funds are used for anything other than qualifying medical expenses, you’ll owe taxes on the withdrawal, plus a 20 percent tax penalty. After age 65, you’ll still owe the taxes but not the penalty.

  • Some HSA providers charge account fees, such as monthly fees or per-transaction fees. You may be charged for account overdrafts or deposits that don’t clear. Ask your HSA custodian for a complete fee schedule.

  • You must be enrolled in a high-deductible health plan to qualify for an HSA.

What happens to an HSA if you change jobs

HSAs are portable accounts. So, if you switch insurance, change jobs or retire, you’ll still have access to your HSA. “It’s yours. You can move it to a different bank or custodian if you want,” Erhart-Graves says.

You can also keep contributing to it as long as you meet the federal rules for eligibility.

If you no longer have medical insurance that qualifies for an HSA, your existing HSA remains there until you use it, move it or invest it, Erhart-Graves says.

How to invest in an HSA

All or part of the funds in health savings accounts can be invested in mutual funds, stocks, bonds and other investment products. It’s a tax-free way to grow your HSA to pay for medical expenses in retirement.

But investing in risky products may mean that your money may not be there when you need it to pay for health care. Luckily, you can also put your money into safe but lower-yielding investments such as a money market fund.

The choice of HSA investment tools differs among plan custodians. Some HSAs are just savings accounts that do not earn much interest, while accounts at traditional brokers offer the potential to invest in high-return assets. Shop around for a top HSA plan with quality investment options and low costs.

Remember that FDIC-insured savings accounts are protected up to $250,000, but stocks and other investments don’t have that safeguard.

HSA vs. flexible spending account (FSA)

HSAs and FSAs have similarities and differences. Here is a comparison of the two to help you decide which option is more suitable for your needs and goals.

  • Contributions to both HSAs and FSAs are tax-free, up to the contribution limits.

  • Distributions from HSAs and FSAs are tax-free as long as the money is spent on qualifying medical costs.

  • HSAs have more growth potential than FSAs because they can be invested.

  • You must have a high-deductible health plan to qualify for an HSA. You can have an FSA with a traditional health plan.

  • Contribution limits to HSAs are higher than FSAs.

  • Unspent HSA funds roll over year after year. If you don’t spend your FSA, you forfeit those funds to your employer, although some employers do have grace periods or allow you to carry over a certain amount.

  • An HSA is portable if you change jobs, insurance plans or retire. An FSA isn’t.

  • You can change your contribution amount to an HSA at any time, but FSA contribution decisions are usually limited to the annual enrollment period.

  • Both accounts often come with a debit card to make paying for and tracking medical expenses easier.

Bottom line

If you have a high-deductible health plan, getting a health savings account is a smart financial move. The tax benefits are big, and it’s a great way to build up money for health care costs.

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