Health Savings Accounts
If you have a high-deductible health insurance plan, you can allocate tax-free income toward your health with a health savings account.
Minimizing out-of-pocket medical expenses is tough when you have a high deductible health plan, but a health savings account can help. A health savings account (HSA) is a savings account where pre-tax money is deducted from your paycheck and pooled for medical expenses. Then you can use the money for qualified medical expenses, like deductibles, copayments, dental or vision costs, and prescriptions. This is one way to lower your overall health care costs.
The Difference Between An HSA and FSA
Your employer may offer an HSA along with other options like a flexible spending account, or FSA. Their acronyms are similar, but there are major differences.
First, funds in an HSA can be rolled over from year to year, unlike FSA money, which is use-it-or-lose-it. If you leave a job, you can take an HSA account with you, while funds in an FSA are forfeited if you don’t spend them before you leave.
If you leave a job, you can take an HSA account with you, while funds in an FSA are forfeited if you don’t spend them before you leave.
If your employer’s health plan doesn’t offer an HSA, you can set one up on your own through a bank or other financial institution. An FSA can only be set up through your employer, but unlike a HSA, an FSA works with a non-high deductible plan.
Qualifying for an HSA
You can contribute to an HSA if you have a high deductible health plan, or HDHP. According to healthcare.gov, a plan is considered HDHP if the deductible is $1,500 or more for an individual or $3,000 or more for a family. If you aren’t sure if your health plan is an HDHP, talk to your manager or an HR representative.
There is a limit to the amount of money you can contribute to an HSA, and it generally increases every year. In 2023, the cap is $3,850 for individuals or $7,750 for families. Keep in mind that federal law restricts overall out-of-pocket medical expenses to $7,500 per individual or $15,000 per family. If you hit that amount in out-of-pocket expenses, your health insurance will cover the rest.
Say your HDHP has a $15,000 deductible for your family. You could max out an HSA so that half of your deductible expenses are paid with tax-free dollars. This could save you up to $1,600 or more in taxes, if you plan to meet the entire deductible.
Employer HDHP Plans and HSAs
An HDHP may be the only health plan your employer offers, or it may be one of several choices. Some employers contribute money to an HSA as an incentive to choose the HDHP, because an HDHP and HSA combo costs them less overall. If you’re not working with an employer-sponsored plan, an HDHP may be a more affordable option for you, even considering the cost premiums and contributions to an HSA.
In some cases, HDHP-HSA plans give you more flexibility when choosing health care providers, but this isn’t always true. For instance, an employer plan may require you to use in-network insurance providers for expenses to count toward your deductible. If you purchase an HDHP yourself, it may be difficult to discover prices ahead of time and, you may not be able to negotiate the lower prices of a group plan.
Using HDHP Custodians
Typically, with an employer-sponsored HDHP, the employer selects a custodian for the HSAs. The custodian is a financial services company that administers the HSA plan. You can usually use a different custodian if you’d like, but you’re on the hook for admin costs your employer would otherwise cover.
Another perk of using the designated custodian is ease of arranging the direct deposit of pretax money. Typically, this money goes into a savings or money market account that makes it easier to access the money. You can either submit expenses for reimbursement or use an account debit card.
The downside of these types of accounts is that you don’t earn much interest.
Using an HSA for Retirement
Some people use an HSA as an investment strategy to pay for health care expenses in retirement. This only works if you can fully fund your HSA and pay out-of-pocket health expenses from your income instead of tapping into the HSA account. You can contribute up to the maximum yearly and let the balance grow, and when you turn 55 you can contribute an additional $1,000 in catch-up contributions until age 65.
If this strategy works for you, look into HSA investment options, which may include stocks or bonds. Most HSA plans require a minimum balance to invest funds, so check with your employer, custodian, or plan admin.
Before you turn 65, HSA funds can only be used for qualified medical expenses—otherwise withdrawals are subject to an additional 20% tax. After age 65, you can use HSA money for non-qualified medical expenses—anything, really—but you’ll owe state and federal taxes on the distributions. So there isn’t a tax penalty, you’ll just owe regular income tax.
It’s possible your health care costs will be higher in retirement, so you could also plan to use the money strictly for those costs and owe no additional tax.
The Choice is Yours
An HSA is a useful tool worth considering for anyone with a HDHP. It’s up to you to decide whether you want to use the funds to manage your current health care costs or to invest for the future.
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