What is a Health Savings Account (HSA)?
Health Savings Accounts (HSA) allows you to use pre-tax income for eligible medical expenses. It is linked to a high-deductible health plan (HDHP) and is intended to cover the out-of-pocket costs.
The HSA is a tax-advantage savings account and provides you with more control over how your healthcare dollars are spent.
Who is Eligible to Enroll in an HSA?
To be eligible for an HSA you must meet the following requirements:
- You are covered by a high-deductible health plan (HDHP)
- You are not enrolled in Medicare
- You do not have other health coverage that is not an HDHP
- You cannot be claimed as a dependent on someone else’s tax return
- You do not have a Flexible Spending Account (FSA) used for medical expenses
HSA or FSA – What is the Difference?
An HSA and FSA will allow you to use pre-tax income for eligible medical expenses. Typically, you cannot be enrolled in an HSA and FSA at the same time. However, there are some situations where this stipulation does not apply. You can contribute to a special purpose FSA and an HSA at the same time. Special purpose FSA funds are typically intended for dental and vision expenses.
There are considerable differences between these 2 types of accounts to be aware of:
HSA (Health Savings Account): You must have a high-deductible health plan (HDHP) to open an HSA. The money in your HSA is yours to keep. It will stay with you, even after you leave your employer.
Your HSA funds can be rolled over from year to year and used to pay for qualified medical expenses.
FSA (Flexible Spending Account): An FSA is controlled by your employer. This means if you leave your current employer the funds in your FSA may be forfeited.
The money in your FSA is not carried over from year to year – with your FSA it’s a use it or lose it benefit.
If eligible, enrolling in an HSA can provide you with greater tax advantages and savings potential.
Three Key Benefits of a Health Savings Account
Benefits associated with an HSA include:
- Tax savings
- Flexibility in spending
- Potential investment opportunities
We will look at each in more detail below.
Tax Saving Benefits of an HSA
When contributing to an HSA, individuals can reduce their taxable income, which can potentially lower your annual tax bill.
2023 HSA Contribution Limits
In some cases, your employer may contribute money to your HSA. The Federal limit in 2023, for combined contributions between you and your employer to an HSA:
- Individual: $3,850
- Family: $7,750
- If you’re 55 or older, you can contribute an additional $1,000
You don’t have to make all contributions in the current tax year. You can max out your contribution by April 15, 2024 for your 2023 taxes.
The Triple Tax-Advantage of a Health Savings Account
Health Savings Accounts offer a triple tax advantage:
- Contributions to your HSA are tax deductible.
- Your money grows within the account tax-deferred.
- You can withdraw money from your account tax-free if the funds are used for qualified medical expenses.
Tax-Efficient Saving Accounts
Let’s look at the different accounts that allow you to tax-efficiently save for your future and compare the tax benefits of each:
- Traditional IRA or 401(k): Your contribution is tax-deductible — you pay income tax on the money you take from the account in retirement.
- Roth IRA or 401(k): You pay income tax on the money you contribute — the money you take from the account is tax-free.
- Health Savings Account: Your contribution is tax deductible, your money grows tax-deferred, and the money you take from the account is tax-free – as long as it is used for qualified medical expenses.
How Can I Use the Funds in My HSA?
Your HSA funds can be used for any qualified medical expenses, including copays, deductibles, and prescription drugs. You can also use your HSA for eligible dental and vision expenses.
The IRS provides an extensive list of qualified expenses. Some non-qualified expenses include elective/cosmetic surgery, life insurance premiums, and childcare expenses.
Considerations When Taking Distributions from Your Health Savings Account
You can use your HSA money on non-medical expenses; however, it may cost you. You could potentially have to pay income tax on the money you take from your HSA and you will incur a 20% penalty on the withdrawal amount.
If you are age 65 or older, you can take money out for non-medical expenses, you will pay income tax on the amount you withdraw. You will want to think about other required minimum distributions that you may be taking and consult with a tax professional when making this decision.
A way to avoid paying income tax and incurring a penalty on your HSA withdrawal is to reimburse yourself for a medical expense you paid in the past. It’s important to note that you must make sure to keep receipts for medical expenses paid out-of-pocket.
Investment Opportunities for My HSA
Another advantage of an HSA is the potential for investment growth. Many HSA providers offer investment options, such as mutual funds. This allows you to invest your HSA funds and potentially grow your savings even further.
Investing your HSA funds is typically best if you can pay your medical expenses out-of-pocket and do not need to reimburse yourself immediately.
If You Don’t Have To – Don’t Spend Your HSA Contributions
This may sound counter-intuitive to how you have traditionally thought of your Health Savings Account. You can think of your HSA as an investment tool to help you achieve your long-term saving goals.