Get the Facts About Health Savings Accounts

Ready to learn about health savings accounts?

Health savings accounts (HSAs) have gained popularity since their creation in 2003 as a smart way to save for healthcare costs. But did you know that HSAs can also serve as a tool for retirement savings? In this article, we’ll explore what HSAs are, who can benefit from them, what risks to consider, which medical expenses are eligible, and how to make the most of your HSA.

What Is a Health Savings Account (HSA)?

HSAs are a financial tool designed for people with high-deductible healthcare plans (HDHPs), which offer lower insurance premiums but higher deductibles. HSAs help you manage healthcare expenses by offering three tax benefits:

  • Contributions. Money put into the account, often directly from your paycheck, represents pre-tax dollars if you have an employer-sponsored HSA.
  • Earned interest and investment gains. Interest earned on your savings and investment returns is tax-free.
  • Distributions. Money saved in your HSA can be used for qualified medical expenses, and these withdrawals are tax-free.

Am I Eligible?

To be eligible for an HSA, you must meet these criteria:

  • HDHP. You need to be enrolled in a high-deductible health plan (HDHP).
  • Coverage. You can’t have other healthcare coverage except for dental, vision, disability, or long-term care.
  • Medicare. You can’t be enrolled in Medicare.
  • Tax status. You can’t be listed as a dependent on someone else’s tax return.

What Are the Benefits of HSAs?

Understanding the advantages of HSAs can help you make an informed decision:

  • Tax savings. Enjoy a triple tax benefit with tax-deductible contributions, tax-free earned interest, and tax-free withdrawals for qualified medical expenses.
  • Employer contributions. Your employer may contribute to your HSA, making it easier to meet your savings goals.
  • Accessibility and portability. Funds in an HSA can often be accessed using a debit card or check. Additionally, funds roll over from year to year and are yours to keep, even if you switch jobs or healthcare plans or retire.
  • Retirement savings. Since the funds in your HSA belong to you, and balances roll over at the end of each year, you can save money for qualified medical expenses over a long period of time. These funds can be used for nonqualified medical expenses with no penalties once you turn 65, but they will be taxed.

Keep in mind that the money in your HSA is yours to keep for life, even if you switch employers or healthcare plans or retire. At the end of each year, unused funds will continue to roll over for life. In other words, the funds in your HSA aren’t “use it or lose it.”

What Are the Risks of HSAs?

While HSAs offer many benefits, there are also some risks to be aware of:

  • High deductible. You are responsible for paying the portion of medical expenses that your insurance plan does not cover until you meet your deductible and potentially your out-of-pocket maximum.
  • Unplanned nonmedical expenses. If you don’t have emergency savings, unexpected nonmedical expenses could keep you from making regular contributions to your HSA.  
  • Additional fees. Some HSA providers charge maintenance or transaction fees, such as for ATM withdrawals or account closures.
  • Possible penalties. Withdrawing funds for non-healthcare reasons will result in penalties, and the withdrawal is taxable.

What Are Qualified Medical Expenses?

The IRS determines eligible medical expenses each year. Common qualified expenses include:

  • Deductibles
  • Copayments
  • Coinsurance
  • Prescriptions
  • Dental expenses
  • Hearing aids
  • Eyeglasses

What Are Nonqualified Medical Expenses?

Certain expenses, like cosmetic procedures or items that are merely beneficial to general health, are not eligible for HSA spending. Examples include:

  • Vitamins
  • Health club membership dues
  • Cosmetics
  • Dental floss
  • Deodorant
  • Lotion
  • Mouthwash
  • Shampoo and conditioner

How Can You Make the Most of Your HSA?

To maximize your HSA’s benefits, consider these contribution options:

  • Contribute the maximum. Contribute the IRS-set maximum amount each year, which varies based on factors like your age and whether it is an individual or family plan.
  • Match your HDHP deductible. Aim to save your insurance deductible amount, enabling you to pay it with tax-free HSA funds. After meeting the deductible, your insurance company is responsible for paying claims under your policy.
  • Cover estimated expenses. Contribute enough to cover your expected annual medical expenses.

How Can You Use an HSA as an Additional Retirement Plan?

Besides covering medical expenses, you can use your Health Savings Account (HSA) to save for retirement.

  • Withdrawing funds. After reaching age 65, you can withdraw money from your HSA for any purpose, but nonmedical withdrawals are subject to regular income taxes.
  • Tax benefits. Similar to 401(k) plans and IRAs, your HSA offers tax benefits, allowing your savings to grow tax-free until retirement.
  • Savings. While annual contribution limits for HSAs are lower than those for 401(k)s and IRAs, HSAs are still a valuable retirement savings tool.
  • Catch-up contributions. If you’re 55 or older, you can make additional catch-up contributions of up to $1,000 annually to your HSA.
  • Potential penalties. Keep in mind that withdrawing HSA funds for nonqualified medical expenses before age 65 incurs a 20% penalty.  

Taking the Next Step To make the most of your HSA, it’s crucial to understand how it works and tailor your contributions to your needs. Speak with your employer, a tax advisor, or financial institution to explore the HSA options available to you, and secure your financial future while ensuring your healthcare needs are covered.

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