Why an HSA is a Good Idea

A health savings account (HSA) has many advantages. The key one is that it helps you save money to pay for out-of-pocket costs on future medical expenses. But an HSA may not fit everyone’s health needs and financial wellness. Please continue reading to find out whether an HSA is a good idea for you.

What is an HSA?

Health savings accounts (HSAs) are like personal savings accounts. However, unlike a regular savings account, you can only use HSA funds for qualified medical expenses. So, you can think of an HSA as a medical savings account.

To be eligible for a health savings account, you must enroll in a high-deductible health plan (HDHP). An HDHP usually covers only preventive healthcare services before you meet the deductible. In 2022, the IRS considers health plans as HDHPs if they have a minimum deductible of $1,400 for an individual and $2,800 for a family. The maximum out-of-pocket cost in an HDHP is $7,050 for individual coverage and $14,100 for family coverage.

You contribute money to your HSA on a pre-tax basis. For 2022, you can contribute up to $3,650 (individual) or $7,300 (family coverage) into an HSA account. You can use these untaxed or pre-tax dollars to pay for qualified medical expenses such as deductibles, copayments, coinsurance, etc. You don’t pay taxes when you withdraw funds, either.

Unlike flexible spending accounts where you lose unused dollars, HSA contributions roll over from year to year if you don’t spend them. Also, any interest earned on an HSA is not taxable.

What is the main benefit of using an HSA?

The main benefits of having a health savings account (HSA) are listed below:

You save on health insurance premiums with high-deductible health plans (HDHPs).
You put aside money on a regular basis to pay for higher out-of-pocket health care costs.
You can pay for a qualified medical expense from your HSA balance.
You save for future health care costs and medical bills, so your HSA acts like retirement savings.
You get a tax deduction (an HSA contribution is not added to your taxable income).
You don’t need to worry about losing unused dollars as you would in a flexible spending account (FSA).
There’s no opening deposit required.
You can invest your HSA funds in stocks, bonds, mutual funds, and other financial instruments. You don’t pay income tax on any earnings or investment gains in your HSA.
Your HSA contribution is portable. If you change employers, you take your HSA funds with you.
HSA contributions can be used to pay for the healthcare expenses of your spouse and dependent children, even if they are not covered in your high-deductible health plan (HDHP).
After retirement, you can use HSA funds to pay Medicare premiums.

What are the tax benefits of an HSA?

An HSA offers a triple tax advantage. Along with the potential tax benefits, your HSA money adds up over time to pay for future health care expenses.

Here are the triple tax advantages or tax savings you get with a health savings account (HSA):

You can contribute to your HSA directly or via payroll deduction. Contributions made directly are eligible for tax deductions. Contributions made through payroll deductions use pre-tax dollars. In either case, you save on federal income tax.
You can invest HSA dollars in stocks, bonds, mutual funds, and other financial instruments. Interest and earnings in your account grow tax-free.
You don’t pay tax on withdrawals for qualified medical expenses.

What is the downside of an HSA?

Health savings accounts (HSAs) offer tax advantages and allow you to build up a fund to pay for qualified medical expenses in the future. However, there are some disadvantages of HSAs that you should be aware of, which are listed below.

Only people with a high-deductible health insurance plan qualify for an HSA. You pay lower premiums for health coverage with high-deductible health plans (HDHPs). However, these plans have high deductibles and out-of-pocket maximums.
The IRS can audit your HSA health care expenses, so you need to keep all receipts for payments made with HSA funds.
If you are under the age of 65 and you withdraw HSA funds to pay for non-qualified expenses, these funds will be considered taxable income. The IRS may also levy a 20 percent penalty for using HSA funds for non-eligible expenses.
After age 65 (when you become eligible for Medicare), you cannot make any additional contributions to your HSA even if you’re still employed.
You must stop contributing to your HSA 6 months before applying for Social Security benefits. Failure to do so may invite tax penalties.
Not everyone is eligible for an HSA. People who are claimed as dependents on someone else’s tax return are not eligible for an HSA.
Some stores may not accept HSA cards. In such a scenario, you will have to pay for your medical expenses out-of-pocket and ask the HSA trustee to reimburse you.
Interest rates on health savings accounts are usually low.
Some trustees charge a monthly fee if your HSA balance drops below a certain threshold.
You need to have a minimum balance before you can invest your HSA contributions.
Investment options for HSA funds are limited, and the investments are not insured.

Is having an HSA worth it?

It depends. You need to consider your individual situation, healthcare needs, and financial goals before deciding whether a health savings account is worth it.

What are the pros and cons of an HSA?

The pros and cons of an HSA are listed above. Here are some additional considerations.

You may have a choice between a health savings account (HSA) and a flexible spending account (FSA), or both. Each has its pros and cons, so you should compare the two before deciding.

In general, HSAs have fewer limitations and more tax advantages compared to FSAs. For example, the funds in your HSA roll over year on year and continue to grow. They can serve as a retirement account to pay for an unexpected medical bill not under insurance coverage during your senior years. As mentioned above, withdrawals from your HSA are tax-free distributions.

The main thing to keep in mind is that the funds in your HSA can be used for qualified medical expenses only. So, if you’re in good health in your golden years, you cannot spend your HSA money on a dream vacation or a grandchild’s college tuition. Using HSA contributions for anything except qualifying medical expenses will invite taxes and penalties, even in retirement.

How much should I contribute to my HSA?

A registered investment adviser or tax advisor is the best person to help you decide how much to contribute to your HSA. Here are some suggestions.

Contribute enough to pay your HDHP deductible. For example, if your HDHP deductible is $1,400, contribute $120 each month so you’ll have the deductible amount saved by the end of the year.
Compare premiums for HDHPs and traditional health plans and contribute the difference. For example, if the premium for a traditional health plan is $500 per month and the HDHP premium is $200 per month, put the difference, i.e., $300, into your HSA every month. This will add up to $3,600 at the end of the year and can be used to offset the higher out-of-pocket expenses associated with your HDHP.
If you can, contribute the maximum amount allowed by the IRS. This changes annually and is $3,650 for 2022 and $3,850 for 2023 (individuals). Family coverage limits are $7,300 for 2022 and $7,750 for 2023. Those over the age of 55 can make a catch-up contribution of $1,000 in 2022 and 2023.

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