When you’re signing up for health insurance at work, you may see the acronym “HSA” and wonder to yourself, “What is a health savings account?”
Here’s What You Need to Know About Health Savings Accounts
Health savings accounts (HSAs) can be a great way to both plan for the future and meet your health care needs right now.
The basic idea with HSAs is that you start with a high-deductible health insurance policy that offers a premium at a lower cost than traditional insurance. Then, taking the money you save in premiums versus traditional health insurance, you can funnel that cash into a tax-free investment account.
Money expert Clark Howard loves HSAs because any money in your account that you don’t use for today’s health care expenses grows over time. It can be tapped for future health expenses even in retirement.
“HSAs are really neat. They are both a tax-advantaged and tax-free savings account for medical expenses,” Clark says. “It is a great deal under the tax code.”
And right now is a unique moment in history when it comes to contributing to an HSA. As part of our nation’s response to the coronavirus pandemic, the Internal Revenue Service has extended the deadline to make 2019 HSA contributions. It is now July 15, 2020 (it was previously April 15).
Table of Contents
- How a Health Savings Account Works
- HSA Eligibility
- Contribution Limits for HSAs
- How to Use an HSA
- HSA Investment Choices
- Eligible Expenses for HSAs
- HSA vs. FSA: Which Is Better?
How a Health Savings Account Works
HSAs consist of two parts:
- A qualified high deductible health insurance policy with a premium that’s typically lower than traditional insurance
- A tax deductible investment account owned by you
With an HSA, you are the one bankrolling a doctor’s visit for the sniffles or an annual checkup. You decide what you’ll pay out of pocket for — essentially acting as your own insurer — and what you want to submit as a claim through your high deductible insurer.
So, we’ve established that you can only contribute to a health savings account if you have a high deductible health plan. That’s generally the kind of health plan that only covers preventive services before the deductible.
The Internal Revenue Service has exact definitions of what qualifies as a high deductible health plan. Here are the current eligibility requirements for a high deductible plan to work in concert with a health savings account:
|Minimum deductible on individual policy||$1,350||$1,400|
|Minimum deductible on family policy||$2,700||$2,800|
|Maximum annual out-of-pocket expenses on individual policy||$6,750||$6,900|
|Maximum annual out-of-pocket expenses on family policy||$13,500||$13,800|
Contribution Limits for HSAs
In addition to caps on minimum and maximums for deductible and out-of-pocket expenses, there are also caps on what you can contribute to your health savings account each year.
Those who are 55 or older can contribute an additional $1,000 more to their HSA each year.
Meanwhile, you can always stay up to date with the latest contribution limits for HSAs on HealthCare.gov.
How to Use an HSA
HSAs let you save money for health care expenses pre-tax. If your employer offers a health savings plan, you’ll typically have money taken out of your check before taxes and deposited into your HSA.
Either way, the money in the account earns interest tax-free. You can spend it on deductibles, copayments, coinsurance and other medical expenses tax-free.
The investment account is yours and is 100% vested. Contributions made by you and/or your employer are fully tax-deductible to you. Even better, investment growth is not taxed while it is in the account.
(Editor’s note: Although HSAs are tax-free at the federal level, some states do tax contributions to HSA accounts. Talk with a tax professional to understand how an HSA would work best with your unique situation.)
So ultimately, you can even use a health savings account as a supplemental retirement account.
How much could an HSA help you out in retirement if you don’t touch the money?
Let’s say a 45-year-old person who never had an HSA before starts contributing $200 a month for the next 20 years. With an average annual return as low as 3%, that money would grow to be $65,000 by age 65. You can play around with your own calculations on this free HSA calculator.
In addition, once you reach retirement age, you can use the funds for expenses not paid by Medicare: deductibles, co-insurance and even Part B and Part D premiums.
HSA Investment Choices
HealthSavings.com offers quotes and other info for individuals looking for HSAs and companies looking to start HSA enrollment for their employees.
The site offers a full suite of 42 Vanguard no-load mutual funds — “no load” meaning they have no commissions or additional sales charges. There’s even a simple money market account available for those who like to take the conservative approach.
Another newer option to come to market is from Fidelity Investments, which rolled out its HSA account offerings for individuals outside employer plans in mid-November 2018.
With Fidelity, you’re also getting low-fee options to save for your future needs while addressing the health care expenses of today.
Meanwhile, if you want to cast your net a little wider, Investor’s Business Daily has its own list of the best HSA accounts ranked by fees, features and investment options.
Eligible Expenses for HSAs
Withdrawals for eligible medical, dental and vision expenses are tax-free. Here’s a partial alphabetized list of HSA eligible expenses, according to the IRS:
- Annual physical examination
- Artificial limb
- Artificial teeth
- Birth control pills
- Breast pumps and supplies
- Dental treatment
- Diagnostic devices
- Disable dependent care expenses
- Drug addiction
- Health institute
- Hospital services
- Hearing aids
- Laboratory fees
- Long-term care
- Medical conferences
- Nursing services
- Prescription medications*
- Stop-smoking programs
- Wigs (medical)
* Reimbursements for insulin are allowed without a prescription in your HSA, according to IRS.gov.
Publication 502 Medical and Dental Expenses on the IRS website always has the latest word on what’s considered an HSA eligible expense.
HSA vs. FSA: Which Is Better?
Health savings accounts and flexible spending accounts (FSAs) may sound similar in name, but there are several important differences:
You own the account with an HSA, unlike with an FSA where the account is owned by your employer.
Since you own the HSA account, there’s no “use it or lose it” mandate like there is with an FSA. With an HSA, the money simply rolls over from year to year (instead of going away) if you don’t touch it.
- An HSA requires you to have a high deductible health plan. An FSA does not.
- You get to direct the investments for your HSA. You have no such ability with an FSA.
Ultimately, the answer to the question of, “Which is better? An HSA or an FSA?,” is highly individual.
As a general rule of thumb, HSAs work best for people who are either young and/or healthy and don’t go to the doctor often. That way, they can let their contributions grow over time without drawing them down too much.
Entrepreneurs in particular get one of the biggest benefits from doing an HSA, according to Clark.
“If I own my own business, I pay so many taxes as a business owner. But an HSA gives me a holiday from the tax burdens and makes it an extra-wonderful choice to grow your money,” he says. “If you can afford the medical bills upfront as they come up through the years, this is a better option than a Roth IRA, a solo 401(k) or a SEP-IRA if you own your own business.”
HSAs can be a real win-win-win situation. You reduce your taxable income by making contributions each pay period, just like you would with a 401(k) at work. The money you earn in interest or investment gains is tax-free, and eligible medical expenses qualify for tax-free withdrawals of the money.
Clark is a big fan of HSAs. Of course, not everyone is as sold on them as he is.
“[Critics] think all of the money is being funneled to the healthy and rich, but I say it’s better than our current system,” Clark says. “Of all the economic output in the United States, 18 cents of every dollar goes to health care. That’s about 50% higher than any other developed country. We are basically sapping our nation’s economic growth with the enormous amount of money going to health care.”
The reality is that those best served by HSAs are people who are disciplined about putting money aside in savings to fund the HSA — and who are fairly healthy and rarely go to the doctor.
On the other hand, if you struggle to pay your monthly bills, have no savings or have a significant ongoing illness, the HSA probably isn’t the best choice for you.