A health savings account, or HSA, is a savvy way to save for medical costs and reduce your taxable income. Read on to see if you qualify and how opening an HSA can benefit you.
What is a health savings account?
A health savings account is an account that lets you set aside pre-tax income for qualified medical expenses.
Healthcare is expensive, but tools are available to help make it more affordable. One tool is a health savings account (HSA). An HSA can help you better control medical costs while saving money on taxes — but not everyone is eligible.
Read on to learn more about how HSAs work, how you can qualify, and if they're right for you.
What is a health savings account?
A tax-free health savings account is designed specifically for qualified medical expenses. HSAs can help you pay for certain medical, dental, and vision costs and those of your spouse, children, or other eligible dependents.
By using untaxed dollars in a health savings account to pay for deductibles, copayments, coinsurance, and other healthcare expenses, you can help lower your overall healthcare costs.
How does an HSA work?
When you have an HSA, you contribute money regularly and use that money to pay for qualified medical expenses. If you qualify for an HSA, you can open one through your employer or independently.
Even if you open an HSA through your employer, you are the owner — but it can be funded by the employee or the employer (or both). If you have an HSA through your workplace, you can set up automatic contributions directly from your paycheck.
Some employers that offer high-deductible health plans also offer HSAs. If yours doesn't, you may be able to open your own HSA account, though you'll only be able to fund it with cash.
Who can open an HSA?
To have an HSA, you must be enrolled in a high-deductible health plan (HDHP). For this calendar year, the deductible must be at least $1,700 for self-only or $3,400 for family coverage.1
There are some additional eligibility requirements as well. To open an HSA, you must:
Not be enrolled in other health care plans (unless permitted by the IRS)
Not be enrolled in Medicare
Not be listed as a dependent on someone else's tax return
Be under the age of 65
What is an HDHP?
A high-deductible health plan is a type of health insurance with low monthly premiums in exchange for a higher deductible. This makes it more affordable monthly but means you'll pay more when seeking medical care.
To fully understand how an HDHP works, you need to understand the following definitions:
Premiums: The amount you pay each month for health insurance coverage.
Deductible: The amount you have to pay for health care services before your insurance plan kicks in.
Coinsurance: Once you reach your deductible, your insurer will pay a percentage of your medical costs, and you'll pay the rest. The amount you pay is called coinsurance.
Out-of-pocket maximum: Once you've paid a certain amount out of pocket (called an out-of-pocket maximum), your insurer will cover 100% of your approved healthcare expenses.
What can I use my HSA for?
After opening an HSA, you will receive a debit card linked to your HSA balance, which you can use to pay for eligible medical expenses. This includes deductibles, copays, coinsurance, and other qualified medical expenses not covered by your plan. Be aware that HSA funds generally may not be used to pay premiums.
Your HSA contributions, which have an annual cap, can be used to pay for medical, dental, and vision care and prescription drugs. Amounts withdrawn from an HSA aren't taxed as long as they are used to pay for services the IRS treats as qualified medical expenses.
Some examples of qualified medical expenses include:
Deductibles
Dental services
Psychiatric treatments
Vision care
Prescription drugs
Co-pays
Consult the IRS or your employer for a complete list of qualified medical expenses. You can also ask whether you are eligible for the medical expense tax deduction, which can save you even more.
HSA vs. FSA
Although a health savings account and a flexible spending account (FSA) can help cover medical expenses, there are some crucial differences.
Ownership: An HSA is owned by the employee, while an FSA is owned and managed by the employer.
Eligibility: To open an HSA, you must have a high-deductible health plan. You can only get an FSA if your employer offers it, but you can get one even if you have a low-deductible plan.
Funds: Any unused money in an HSA will roll over at the end of the year and stay in the account. With an FSA, you must use it by the end of the tax year, or you'll lose it.
Limitations: You may be taxed if you use money from an HSA to pay for a non-qualified expense. With an FSA, you may need to pay medical bills up-front and submit a claim for reimbursement.
Health savings account rules and limits
An HSA can help you pay for medical expenses, but there are several rules and limits to be aware of.
HSA withdrawal rules
You won't pay tax if you use the money in your HSA to pay for a qualified medical expense. But if you use it for a non-qualified expense, you may be subject to income tax plus a tax penalty of 20%.2
HSA contribution limits
You decide how much to contribute to your HSA account each year, though you cannot exceed government-mandated maximums. This year, you can contribute up to $4,400 if you have self-only coverage or up to $8,750 for family coverage.1
If you're 55 or older, you can contribute an additional $1,000 per year as a "catch-up" contribution.2
Advantages and disadvantages of an HSA
Like most healthcare options, health savings accounts have advantages and disadvantages. As you weigh your choices, consider the pros and cons before opening an HSA.
Pros
Any unused funds automatically roll over to the next year with no use-it-or-lose-it mandate.
An HSA may earn interest or other earnings which are not taxable.
You can keep your HSA if you change employers.
The money in an HSA can be used for yourself and any tax dependent.
Employer contributions don't need to count toward your gross taxable income.
You can claim a tax deduction for contributions to the HSA.
Cons
You have to abide by maximum contribution limits.
There are strict eligibility requirements to qualify for an HSA.
You must be able to cover a substantial portion of your HDHP's deductibles.
Illness can be unpredictable, making it hard to budget for health care expenses accurately.
You must pay taxes if you take money from your HSA for nonmedical expenses.
Some may find it challenging to set aside money to put into their HSAs.
Should I get a health savings account?
For many, a health savings account is a tax-friendly way to pay for medical expenses. Starting an HSA early, if you qualify, and allowing it to accumulate over time, can contribute significantly to your financial and medical health. Overall, HSAs can be an excellent tool for covering your healthcare costs — now and in the future.
Learn how to negotiate medical bills to help decrease your overall expenses.