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The idea of tax-free spending on qualified medical expenses is a promising one and is one offered by Health Savings Accounts or HSAs.
While the HSA has a significant number of restrictions, those who qualify to open an HSA will find that the benefits of owning one are excellent.
HSA Fast Facts
- Savings account allowing for tax-free spending on qualified medical expenses
- Money rolls over from year to year
- Must be enrolled in a high-deductible health insurance plan to participate
- Money in the fund can be invested in mutual funds
What Is a Health Savings Account (HSA)?
A Health Savings Account is a savings account for anyone enrolled in a high-deductible health insurance plan or HDHP that allows for tax-free spending on qualified medical expenses.
HSAs can be used for a variety of medical expenses but not used to pay premiums.
How Do HSAs Work?
HSAs allow owners to pay for qualified medical expenses with tax-free dollars by using any money put in an HSA to reduce their taxable income, much like how money invested in a Traditional IRA works at tax time.
Because advantageous tax practices are involved, the government regulates HSAs. Therefore, there are quite a few regulations in place so that there are no tax-free loopholes everywhere.
Once the account is established, owners can contribute up to $3600 per year for their personal coverage or $7200 for family coverage.
Distributions can then be made from the account to pay for qualified medical expenses like medical equipment, co-pays, deductibles, prescriptions, over-the-counter medications, and even acupuncture.
Funds in the savings account that are not used from year to year roll over to the next, so there is no risk of “use it or lose it.”
HSAs are also permitted to be investment accounts as long as an HSA custodian allows investing. This is great news for HSA participants because any growth in the account is also tax-free.
Employers can offer HSAs, but employees may still open an HSA individually even if their employer does not offer them as long as they qualify.
Qualification Requirements for a Health Savings Account
Not everyone can participate in an HSA. Health Savings Accounts are reserved for those people who are in an HDHP or high-deductible health plan.
These plans essentially only cover preventative services. Deductibles in these plans generally start at $1400 per person or $2800 per family. The plan must also have a maximum out-of-pocket expense of $7000 for an individual or $14000 for a family.
HSA participants must have no other health coverage beyond their HDHP and cannot be enrolled in Medicare.
Lastly, anyone who is claimed as a dependent on someone else’s tax return cannot open an HSA.
Health Savings Accounts Contribution Limits
A single person is allowed to contribute up to $3600 in their HSA account per year. A person contributing to their family can deposit up to $7200 in the account. These contribution limits historically increase every year.
HSA Tax Advantages
Health Savings Accounts are tax-advantaged in three different ways. First, all money invested in an HSA reduces taxable income and is considered “tax-free.”
Additionally, money earned in the account through investment is not taxed. There are no taxes on money distributed from the account for qualified medical expenses.
HSA Pros and Cons
- Tax-advantaged spending three ways on qualified medical expenses
- Money in HSAs rolls over from year to year
- HSA funds can be invested
- Debit cards and checks provided that are linked to your account
- Premiums cannot be paid
- In order to participate, you have to have an HDHP
Flexible Saving Accounts
Health Savings Accounts or HSAs and Flexible Savings Accounts or FSAs offer many of the same benefits to the person using the account in that both are tax-free savings accounts that allow tax-free spending on qualified medical expenses.
Despite what the names suggest, Flexible Spending Accounts are not actually as flexible as HSAs. The reason lies in the ownership.
HSAs are owned by the individual, and FSAs are owned by the employer. Funds not used at the end of a year or grace period in a Flexible Spending Account are forfeited to the account owner or the employer.
Health Savings Accounts FAQs
What Is the Downside of an HSA?
The type of insurance account that you have to have to participate in an HSA just does not make sense for most people.
Any money pulled out of an HSA to pay for something other than qualified medical expenses will be taxed, so it is important not to over contribute.
Are HSAs Good or Bad?
HSAs are a great tool for those who are in a High Deductible Health Plan and don’t have any supplemental insurance.
HSAs offer a lot of flexibility in what is considered a qualified medical expense, and the money rolls over from year to year.
HSA funds are also able to be invested, which allows HSA owners to grow their money.
Even though HSA owners can no longer contribute to their HSAs after they reach the age of 65, they are eligible to still pull money from their HSAs.
Is HSA Good for a Family?
While this is a personal decision you have to make, here are a few of our thoughts. A health savings account can serve as a safety net and can help offset truly unexpected and large medical expenses.
Moreover, if you are fortunate enough to never use the funds allocated in your HAS, it will still serve as a tax-free retirement savings vehicle.
How Much Should I Put in My HSA?
Contribution limits for HSAs are $3600 for an individual or $7200 for a family, but just because you can invest that much does not mean that you should.
Owners of HSAs are not doing themselves any favors if they have to put money in just to pull it back out.
HSA contributions should balance everyday budgetary constraints with the benefit of having tax-free money for medical expenses.
Bottom Line: What Is a Health Savings Account?
A Health Savings Account is an excellent opportunity for people in an HDHP to have tax-free dollars to spend on qualified medical expenses.