A health savings account (HSA) allows you to invest for future medical expenses, while enjoying special tax breaks. Your contributions reduce your taxable income and your money grows tax free. Your withdrawals are also tax-free as long as you use the money on qualified medical expenses. We’ll explain how to open an HSA and how you can make the most out of your savings. We can also connect you with a financial advisor, who can help you make the right financial decisions around healthcare expenses.
How to Qualify for an HSA?
To open an HSA, you need to pair it with a high deductible health plan (HDHP). Fortunately, this is a common type of health insurance plan. According to the IRS, an HDHP must meet the following requirements for 2019.
- Minimum deductible: $1,350 (self-directed) or $2,700 (family plan)
- Maximum out-of-pocket costs: $6,750 (Self-Only) or $13,500 (family plan)
So if your plan meets these requirements, you can open an HSA. Your employer may offer one. But if yours doesn’t, you can open one through most banks and financial institutions.
Tax Benefits of an HSA
HSAs are among the most lucrative options when it comes to saving for medical expenses in a tax-advantaged account.
First, your money goes into the account on a “pre-tax” basis. This means it comes out of your paycheck before Uncle Sam takes his cut. As a result, it reduces your taxable income and the government ends up taxing you as if you made less money. Because of America’s progressive tax code, you essentially pay less in taxes as a result. Let’s put that into perspective.
Say you’re single making $40,000 a year. You contribute $3,000 to your HSA this year. That means the IRS taxes you as if your gross income was $37,000.
In addition, your money grows tax free. So you won’t be taxed on any interest, capital gains or any other appreciation of your money in the HSA account. This isn’t the case with savings accounts or investment vehicles like brokerage accounts.
In fact, your contributions aren’t subject to FICA taxes, or the federal income tax taken from your paycheck to cover Social Security and Medicare. Even tax-sheltered retirement savings accounts like 401(k)s don’t get that treatment.
In fact, many HSA providers allow you to create an investment portfolio around your HSA using low-fee funds of your choice.
And your withdrawals are also tax-free if you use them on qualified medical expenses, as defined by the IRS. It actually covers a large range of services. More on that later. For now, let’s take a look at more of the benefits.
You’d be happy to know your money stays in the account even if you don’t use it by the end of the year. This isn’t the case with other medical savings vehicles such as flexible savings accounts (FSAs). Furthermore, your money essentially can grow indefinitely. You don’t have to use it before reaching a certain age. I When it comes to many types of retirement plans, you must take required minimum distributions (RMD) every year beginning when you reach the age of 70.5.
This is one reason why many people use HSAs to cover medical expenses during retirement, when you can expect to need frequent treatment.
HSA and State Tax Rules
So far, we’ve discussed the federal tax advantages of HSAs. However, your earnings may be taxed at the state level. This can be a specific concern if your HSA invests in securities like stocks and mutual funds.
For now, more than 30 states including New York and Pennsylvania don’t tax HSAs.
But any time you’re pondering the state tax implications of HSAs, you might want to find a financial advisor to discuss your situation.
HSA Contribution Limits for 2019
The IRS sets HSA contribution limits each year. But these are typically high. For 2019, the maximum HSA contribution is $3,500 for a self-directed plan or $7,000 for a family plan.
But if you’re at least 55-years-old, you can make an additional catch-up contribution of $1,000 into your account.
Keep in mind the total contributions include your contributions as well as those made by your dependents and your employer if applicable.
However, you can deduct that full amount from your taxable income for the year.
And as we mentioned, some companies make contributions to their own employees’ HSAs. So let’s say your HDHP deductible is $2,000, and your employer contributed $1,000 toward your HSA. Then, you run into an emergency and owe an $8,000 medical bill. You can use your employer’s contribution to cover part of that deductible. As a result, you’d owe just $1,000 out-of-pocket to cover the deductible before your insurance kicks in. You can then use HSA money to pay for required coinsurance and copays until you reach your health insurance plan’s out-of-pocket maximum.
How Does an HSA Work?
If you opened an HSA through your employer, you’d likely have a menu of different fund options to build an HSA portfolio with. The process is similar to that of a 401(k) plan.
Your company would automatically deduct your contributions directly from your paycheck and use it to fund your account. You can choose what percentage of your income you’d like to have deducted from your paycheck and deposited into your HSA.
But if you opened an HSA through a bank or other financial institution, you may have much more fund options. But you won’t have access to any employer match even if your company offers one to its employees enrolled in the company HSA.
Regardless of where you opened your HSA, however, several HSA providers will supply you with a debit card linked to your HSA balance. But with some plans, you may need to submit documentation to get reimbursed for qualified medical expenses. So make sure you keep a paper trail of all your hospital visits.
To help you make the right choice for you, we analyzed HSA options offered by different providers and published a study on the best HSAs available today.
What Does an HSA Cover?
Qualified medical expenses include treatments to alleviate or prevent physical or mental illnesses. So you can use your HSA funds to cover everything from acupuncture to X-rays.
You can also use HSA funds to chip away at your deductible. This is the amount of money you must use to pay for medical expenses before your insurance company starts contributing. But you can also use HSA money to cover copayments and co-insurance.
Furthermore, you can use your HSA to pay for eligible dental and vision expenses even if your health insurance plan doesn’t cover these services. Plus, these benefits extend to your spouse and any dependents under the age of 26 even if they enroll in different health insurance plans.
And during emergencies, those with mobility issues can use HSA money to pay for transportation such as a taxi service to a nearby medical facility. This perk can steer you clear of expensive ambulance trips.
However, HSA funds can’t cover all medical or health-related expenses. So don’t expect your HSA money to count toward expensive gym memberships or the next big workout craze. You also can’t use HSA money to cover services like teeth whitening, cosmetic surgery or over-the-counter medications.
Unfortunately, you can’t use HSA money to pay for basic insurance plan premiums.
For a full list of HSA qualified medical expenses, visit Section 213(d) of the Internal Revenue Service Tax Code. Your HSA balance can cover these expenses penalty and tax free. But you still have to follow some rules.
How To Open an HSA?
The first place you should seek an HSA is at your employer’s benefits or human resources department. However, you can also open one at most banks and financial institutions. But be sure to shop around.
Some banks offer better interest rates on their HSAs tha others. Financial services firms can invest your HSA money in mutual funds and other securities. However, some charge larger fees than others. Meanwhile, some charge none.
So make sure you work with a firm that charges low-or-no fees on your account and requires no minimum balance. You should also pick a fund or funds that are right for your risk tolerance. If you’re not certain how yours measures up, you can use our asset allocation calculator. It gives you a glimpse of what a typical investment mix may look like based on different risk levels.
Disadvantages of HSAs
Despite their many benefits, HSAs may not be the best medical savings accounts for everyone. For starters, you need to pair it with an eligible HDHP. Most people find these health insurance plans are beneficial because they usually require low premium payments. These are the monthly payments you make just for having health insurance.
However, these plans also involve large deductibles as their names imply. Most financial advisors recommend these types of plans to people who don’t expect to need much medical treatment.
But if you suffer from a chronic condition, have children or require frequent medical attention, you want your insurance to start taking the slack as soon as possible. HDHPs and thus HSAs may not be suitable for these types of people.
In addition, you can’t contribute to your HSA if you’re at least 65-years-old and enrolled in Medicare. Nonetheless, the money in your account still grows tax free. Plus, you can also use your HSA funds to pay for Medicare parts A, B, D and HMO premiums tax-free.
If you feel like an HSA may not be for you, consider a flexible spending account (FSA). You don’t need an HDHP to open an FSA. But keep in mind that you’d have to use your FSA savings within the year or you’d forfeit them. Still, you’re more likely to use these funds if you often seek medical attention throughout the year. So be sure to consider HSA vs. FSA before you make a decision.
Of course, you can find several ways to get more from your health savings account. But you obviously need to contribute as much as you can. So if you can’t set enough money aside each month, your HSA won’t live up to its full potential. Try developing a good savings habit and cutting down on debt first.
HSAs serve as beneficial savings vehicles that can help you pay for future medical expenses. They also offer tax breaks you’d find nowhere else. And if your employer offers one with a company match, you could be looking at one of the best health savings vehicles around. However, HSAs won’t suit everyone. After all, you still need an HDHP to get one. These types of health insurance plans tend to best benefit young and healthy people who don’t expect much medical attention and want to keep premiums low. If you’re likely to need frequent medical services, you may be better off with a low-deductible health plan. This arrangement makes it easier for you to reach your deductible, so your insurance can kick in as early as possible.
Tips on Saving for Medical Expenses
- If you invest in mutual funds or other securities through your HSA, watch out for high fees and other restrictions. Some HSA providers require high minimum investments, while others require none.
- Work with a financial advisor to build the right HSA portfolio with low-cost funds to make the most out of your investment. If you’d like professional help with managing your HSA, you can use our financial advisor matching tool. All you have to do is answer some simple questions about your financial goals, and the tool will connect you with up to three advisors in your area. We vetted each one, but you can still access their profiles to compare their qualifications before deciding who to work with.
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