What is a Health Savings Account?
A Health Savings Account, or HSA, is a way to save for medical expenses and reduce your taxable income. HSAs could be a good way to help plan for your medical expenses.
You need to think if an HSA fits into your life. There isn’t a right or wrong answer to this and it depends if you need an HSA or not.
Studies show approximately 26 million people use HSAs to save and pay for medical expenses. To be eligible for an HSA, you have to be enrolled in a high deductible health plan (HDHP) to get a health savings plan. Basically, this means you pay a high deductible before your health insurance kicks in. The money you put into the HSA is saved for future medical expenses.
The IRS publication 969 states that “no permission or authorization from the IRS is necessary to establish an HSA. HSAs are set up through a trustee. A qualified HSA trustee can be a bank, an insurance company, or someone approved by the IRS to be a trustee of individual retirement arrangements (IRAs) or Archer Medical Savings Accounts (MSAs).
Some employers who offer high deductible savings accounts offer HSAs. If your company does not, then you can open an HSA as long as you have a qualifying plan.
If you have a lot of medical expenses, then you may want to consider adding an HSA. You will need to decide, look at your current medical expenses as well as your budget. The HSA is not right for everyone.
If you decide to contribute to an HSA, you have to look at this account as a source for medical funding. Then this new source of money could factor into another source for your retirement planning.
The HSA offers several benefits for you to consider.
- An HSA is a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions. Schedule A (Form 1040).
- Contributions made to your HSA may be excluded from your gross income.
- Contributions remain in your account until you use them.
- The interest or other earnings in the account grow tax-free.
- If you pay qualified medical expenses, money you take out for medical expenses is considered tax-free.
- An HSA is “portable” and moves with you if you change employers or leave the workforce.
HSA benefits you do not use one year, roll over into the next year. You can still add HSA contributions each year even if you did not use money from the previous year.
For tax purposes, let’s look at this example. For example, if you make $40,000 a year and you want to make a contribution to an HSA, this is something to consider. The HSA costs $3,000, then your income will be taxed at $37,000 as the HSA lowers your tax liability.
If you make eligible withdrawals from your account, the money is not taxed.
HSAs contributions provided through your employer could be pre-tax and you will need to verify this information with your HSA administrator.
IRS Form 8889 — this form is required when you make contributions and withdrawals in a calendar year with your HSA.
IRS Form 1099-SA — this form documents HSA withdrawals.
Many companies offer you the ability to invest your HSA in stocks, ETFs, and mutual funds. Talk to your HSA representative for more details on what they offer and your investing preference.
Some HSAs may require that you have a certain amount in your HSA before you can invest. For instance, you may be required to have $1,000 in your HSA before you can invest your money.
When you decide to open an HSA account, you will need to decide how much you want to fund the account without going over the government maximum. If your employer provides the HSA, then you can work out how much to deduct from your account each month from payroll.
HSA screenshot by writer
Your HSA custodian will provide you a debit card or checks to pay for eligible medical expenses. Medical expenses include coinsurance, copays, deductibles, and other medical expenses not covered by your medical plan. Take note, that insurance premiums cannot be paid with your HSA.
A Flexible Spending Account (FSA) is similar to an HSA. The main difference is the FSA must be used during that year. The FSA money does not rollover like it does with an HSA.
Another difference with an FSA is that you are not required to have a health insurance plan. Your FSA provider may have more specific details on what is covered.
You may wonder what can you use your HSA for? This is the list of expenses that qualify under an HSA.
- Dental treatment
- Doctor’s office visits and copays
- Drug prescriptions and over-the-counter medicines
- Eye exams and eyeglasses
- Flu shots
- Physical therapy
- Surgery (except cosmetic surgery)
Some medical expenses that typically are not covered include gym memberships and essential oils for aromatherapy. If you are unsure what is covered by your HSA, refer to your HSA provider.
When you are 65 and older, you can no longer contribute to an HSA. Money you have available for use in your HSA is the same as having money in a traditional IRA. The money in the account can be used for anything you like but you will pay taxes when you make a withdrawal. Medical expenses are still tax-free.
Recent changes during COVID and the Coronavirus Aid, Relief, and Economic Security (ACT) allow HSA users to use an HSA for over-the-counter medication without a prescription and other health-related products. You may need to verify with your HSA provider or pharmacist what is covered.