A Health Savings Account (HSA) provides a tax-advantaged way to pay for medical expenses. Understanding how HSAs work and maximize benefits helps consumers leverage them as part of a healthcare financing strategy.
What is a Health Savings Account (HSA)?
A Health Savings Account is a special bank account allowing you to set aside pre-tax or tax-deductible funds to pay for qualified healthcare costs. HSA contributions are tax-free and money in the account accrues interest tax-free.
To open an HSA, you must be enrolled in a qualified High Deductible Health Plan (HDHP). HSAs are owned by the individual and portable from employer to employer. Unused balances roll over yearly.
HSAs give tax incentives to save for medical expenses while building long-term savings. Account holders get a triple tax advantage.
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How Do HSAs Work?
HSAs function similarly to other pre-tax benefits accounts with a few unique aspects:
- You contribute pre-tax or tax-deductible money from your paycheck into the HSA which lowers your taxable income.
- Funds accumulate in the account tax-free and can be invested to grow the balance long-term.
- You use the HSA to pay for eligible medical, dental and vision costs tax-free at any time.
- Money left in your HSA rolls over yearly and remains yours even if you change health plans or employers.
HSAs incentivize saving for healthcare costs while allowing account holders to control how and when money gets used.
HSA Eligibility Requirements
To open and contribute to an HSA, you must:
- Be enrolled in an HSA-qualified High Deductible Health Plan (HDHP)
- Have no other non-HSA-compliant health coverage like a spouse’s plan
- Not be enrolled in Medicare or TRICARE
- Have no Veterans Administration (VA) benefits used in the past 3 months
- Not be claimed as a dependent on another person’s tax return
- Be younger than age 65, unless only enrolled in Medicare Part A
Review all current coverage to ensure no conflicts preventing HSA enrollment exist. HSAs remain under your control even if you later transition off a HDHP.
HSA vs Health FSA Differences
While both offer tax advantages, key differences exist between HSAs and Health Flexible Spending Accounts (FSAs):
- Must have a qualified HDHP
- Contributions not use-it-or-lose-it
- Funds roll over annually
- Portable when leaving employer
- Can invest balances
- Can be paired with any health plan
- Lose unused money at year end
- No rollover or investment options
- Employer-owned accounts
- Limited contribution amounts
HSAs function more like long-term savings vehicles while FSAs focus on short-term medical cost reimbursement.
HSA Contribution Limits
Annual HSA contribution limits set by the IRS are:
- 2023: $3,850 for individual coverage or $7,750 for family coverage
- 2022: $3,650 for individual coverage or $7,300 for family coverage
- 2021: $3,600 for individual coverage or $7,200 for family coverage
- Catch-up contributions: $1,000 extra if age 55+
If you join an HDHP later in the year, contribution limits get prorated based on the number of full months you were enrolled. Limits include both personal and any employer contributions.
HSA Investment Options
You can grow your HSA tax-free through investment earnings:
- Most HSAs allow investing balances over $1,000 or $2,000.
- Wells Fargo, Fidelity, and Optum Bank offer integrated HSA investment options.
- Or you can invest through external brokerages by transferring funds.
- Typical investment mixes incorporate stocks, bonds, mutual funds, ETFs.
- Investments involve standard market risks like other non-retirement investment accounts.
Earnings generate added tax-free growth on top of original contributions. HSAs become additional retirement readiness vehicles.
Using HSA Funds
Money in HSAs can be used tax-free to pay for qualified medical expenses including:
- Health plan deductibles and coinsurance
- Dental and vision costs like exams, cleanings and eyeglasses
- Prescription medications, copays and other drug costs
- Medical equipment like crutches, blood sugar monitors and wheelchairs
- Chiropractic visits, acupuncture and physical therapy
- Travel costs related to care like mileage or parking fees
Keep documentation showing HSA funds used for qualified healthcare purchases in case of IRS review.
HSA Distributions and Withdrawals
Withdrawing funds works similarly to other bank accounts:
- Use provided debit cards connected to your HSA at points of care to directly pay providers.
- Withdraw money at ATMs using the HSA debit card to reimburse yourself for eligible expenses paid out-of-pocket.
- Transfer funds to personal checking or savings accounts electronically for reimbursement.
- Arrange recurring claim-based distributions where insurers automatically pay providers from your HSA up to available balances.
Withdrawals used for non-qualified purposes face a 20% penalty plus tax exposure if under age 65. Keep tabs on spending to avoid fees.
HSA Custodian and Set Up
Steps to establish an HSA include:
- Select an HSA administrator or custodian. Check fees, investment options, and convenience factors.
- Employers often partner with specific HSA providers but you can use any qualified custodian.
- Work with HSA provider to complete application, including employer information if contributing through payroll.
- Custodian processes paperwork and sends enrollment confirmation when account is active.
- Follow provided instructions to activate online account access and review investment selections.
Several HSA custodians like Fidelity, Optum Bank, and Discovery Benefits compete for your deposits. Compare carefully.
HSA Record Keeping
Proper ongoing account management involves:
- Tracking contributions – Know limits to avoid over-funding and stay compliant.
- Saving receipts – Keep documentation showing distributions used for qualified medical expenses in case of IRS inquiry.
- Investing wisely – Make thoughtful investment elections managing risk and time horizons.
- Paying monthly fees – Certain accounts charge administrative fees. Keep current to avoid account closure.
- Filing tax forms – Submit required IRS forms for contributions, investment income and distributions.
Stay organized following HSA reporting rules to maximize benefits while avoiding penalties.
HSA Coordination With an HDHP
HsAs pair with HDHPs as a healthcare financing strategy:
- The HDHP provides catastrophic protection for major medical events. But the high deductible leads to greater upfront costs for routine care.
- The HSA covers HDHP copays, coinsurance and deductibles with tax-free dollars. This helps bridge the coverage gap.
- Once the deductible is met, the HDHP provides protection from further large expenses.
- HSAs pay current costs while also serving as long-term medical savings.
Together, HSAs and HDHPs provide comprehensive coverage while controlling premium expenses.
Advantages of using a Health Savings Account include:
- Triple tax advantage – Contributions go in tax-free, balances grow tax-free, and distributions for healthcare come out tax-free.
- Pay for expenses tax-free – Eligible medical purchases avoid being subject to income and payroll taxes.
- Savings option – Funds roll over yearly to accumulate long-term reserves for future healthcare costs.
- Portable – You keep the HSA even if you change health plans or employers. Accounts are personally owned.
- Retirement option – After age 65, distributions can be taken for any purpose without penalties being assessed.
HSAs provide flexibility to save and spend efficiently for healthcare along with unique tax benefits.
Downsides of HSAs include:
- Must have qualifying HDHP – HSAs can’t be opened independently, limiting access. But contributions aren’t required annually.
- Raised deductibles – Transitioning to an HDHP means potentially higher upfront costs before the health plan starts sharing expenses. HSAs help offset this impact.
- Limitations on other insurance – No other non-HSA-qualified policies can be held limiting supplemental options.
- Penalties if ineligible – Distributions for ineligible expenses before age 65 face a 20% penalty along with taxes owed on the funds.
- Administrative responsibilities – Proper documentation and tax reporting falls on the individual account holder.
While beneficial, weigh HSA restrictions against your financial and healthcare priorities before enrolling.
HSA Mistakes to Avoid
Common HSA issues that create problems include:
- Not obtaining an HDHP first before opening an HSA.
- Exceeding the yearly maximum contribution limits across sources.
- Not keeping distributions for ineligible expenses separate from medical transactions.
- Failing to track reimbursed expenses in case of an IRS audit.
- Not designating a beneficiary which complicates account transfer upon death.
- Not rolling over employer HSA balances to an individual HSA upon separation from the company to maintain access.
Proactively sidestepping pitfalls allows you to seamlessly utilize HSA benefits.
Frequently Asked HSA Questions
Can I have an HSA and FSA together?
No, FSAs are considered “impermissible other coverage” for HSA eligibility unless they are limited to dental, vision or post-deductible expenses only. Most people are best served choosing either an HSA or FSA, but not both.
What happens to my HSA if I leave my employer?
HSAs are portable and go with you even if you leave your employer. You have full control over the account. You can arrange to continue contributing on your own or via a new employer’s benefits plan.
Do I forfeit unspent HSA balances at the end of the year?
No. Unlike FSAs, leftover HSA funds roll over from year to year without expiration. Your balance continues growing over time with additional contributions and investment earnings.
Can I reimburse myself in the future for current expenses from my HSA?
Yes, you can pay out of pocket now for qualified expenses and reimburse yourself using HSA funds later. As long as care was incurred after your account was opened, distributions are allowed in the future.
What happens to my HSA when I turn 65?
At age 65, you can continue using the account tax-free for medical expenses. Once on Medicare, you can no longer contribute to an HSA. And distributions taken for non-medical purposes avoid the 20% penalty but are taxed as income if under age 65.
Maximizing Health Savings Accounts provides unique advantages to save, grow, and access funds for healthcare expenses. Evaluate if the benefits fit your situation.