Many workers are able to reduce their health insurance premiums by signing up for a high-deductible health insurance plan and pairing it with a health savings account. HSAs provide a triple tax benefit: You don’t have to pay income tax on your contributions, the money in the account grows without being taxed and the funds can be withdrawn tax-free when used to pay for medical expenses. Unlike a flexible spending account, the money in your HSA can be rolled over from year to year and be used for future medical care needs, even during retirement. Here’s how to decide if a health savings account is right for you.
What is an HSA? HSAs allow you to regularly designate funds for upcoming medical needs. “A HSA is a personal savings account for health expenses,” says Shobin Uralil, co-founder and COO of HSA provider Lively. To be eligible for an HSA, you must be enrolled in a high-deductible health care plan. In 2019, an HDHP is defined as a plan with a deductible that is at least $1,350 for an individual or $2,700 for a family. Once you have an HSA, your employer can contribute to the account as well. In 2019, the maximum amount that can be put into an HSA is set at $3,500. A family has a contribution limit of $7,000. You can use the money in the HSA to pay for qualifying medical expenses such as deductibles and copayments.
Reduce taxes with an HSA. One of the key benefits of an HSA lies in the triple tax benefit associated with this type of account. “Contributions are typically made with pretax dollars,” says Taylor Hammons, head of retirement plans at Kestra Financial in Austin, Texas. In addition, when you use the money in the account to pay for qualified health care expenses, you won’t have to pay taxes on the withdrawals in most states. If the money in the account is invested and grows, you also don’t have to worry about tax-related expenses on the investment gains. “Any earnings on the assets in the account are tax-free,” Hammons says.
Save for future medical costs with an HSA. There’s no time limit on the assets you accumulate in an HSA. “If there is a balance left in the HSA at the end of the year, it rolls over to the next year for future use,” Hammons says. This means that any money you put into the account and don’t take out has the potential to grow. Over time, the amount in the account could increase and be used to fund later medical expenses like long-term care.
Decide if a high-deductible health care plan is right for you. If you’re thinking about opening an HSA, you’ll want to evaluate your current health plan. If your employer offers both high-deductible and low-deductible health plans, compare the costs associated with each option. Look at what you might pay in monthly premiums, a deductible and copayments. “Since the HSA is only available with a HDHP, the monthly premiums are generally lower than the premiums associated with a low-deductible health plan,” Hammons says.
HSA age limits. “HSAs can be used by anyone younger than age 65,” says Lisa Zamosky, senior director of communications at eHealth, a private online health insurance exchange. After age 65, you can continue to withdraw funds for medical expenses but you won’t be able to make more contributions. If you’re a younger adult and don’t visit the doctor that often, you might benefit from being able to save a greater amount in an HSA. “Older folks who are more investment savvy sometimes like HSAs because they have the funds to make the most of them,” Zamosky says. There are also special benefits for those approaching retirement: Individuals who are 55 or older can deposit an extra $1,000 into the account each year.
What medical costs can HSA funds be used for? If you have a medical condition that requires ongoing treatment, make sure money in an HSA can be applied to your particular needs. “There’s a long list of things you can pay for with HSA money,” Zamosky says. In addition to using the money for your deductibles and copayments, HSA funds can pay for dental and vision care costs, acupuncture, chiropractic care, in vitro fertilization, prescription drugs and costs associated with guide dogs and other service animals.
Take care to avoid HSA penalties. Withdrawals from HSAs that are not used toward medical expenses will face charges. “If amounts are used for anything other than qualified medical expenses, then the distribution is subject to income tax and an additional 20 percent penalty tax,” says Barry Kozak, a consultant at October Three Consulting in Chicago. Those age 65 and older can withdraw funds without penalty for nonqualified expenses but will still have to pay income tax on the distribution.
How to invest your HSA. Before getting an HSA, think about the contributions you’ll be able to make. “You’re only going to get the most out of your HSA if you can afford to make contributions to your account on a regular basis, at least until you have enough to cover an annual deductible,” Zamosky says.
Also keep in mind that the money you put into the account remains yours. Even if you switch jobs, the account will continue to belong to you. This means you can incorporate your HSA into long-term savings plans. You can invest the money in your HSA in stocks, mutual funds, exchange-traded funds and other investment options, depending on how soon you expect to need the money. “Younger and healthier employees can max out their HSA deferrals, and if they only use a portion each year to pay premiums but incur no additional expenses, then they will have balances that accumulate and earn compound interest over time,” Kozak says. “Similarly, older and wealthier employees can max out their HSA deferrals.” If you have other funds that can be used to pay current medical expenses, you’ll be able to let the money remain in your HSA. This eventually can provide a source of funding to cover health care expenses in retirement.