The costs of health care seem to be consistently rising. Even with insurance, it’s challenging for many people to keep up with. One option that can help you cover healthcare costs is a health savings account or HSA.
These accounts have been a lifesaver to many people when it comes to being able to cater to their health even at the time of financial crisis. If you are learning about health savings account for the first time, this post will tell you everything you need to know about it.
Here, we will discuss what these accounts are, the pros and cons, and some of the lesser-known benefits of HSAs so you can decide if this could be a good financial choice for you. So, let’s get straight into it.
An Overview
A health savings account or HSA is similar to a personal savings account, but the difference is that you can only use it for qualified healthcare expenses. You have to be enrolled in a high-deductible health plan to qualify to open an HSA.
A high-deductible health plan or HDHP is a health insurance plan with a large deductible for medical expenses. The annual deductible is usually in the thousands of dollars, but the tradeoff is that you pay lower monthly premiums. An HDHP will often cover routine preventative carefully, so you might not have to pay coinsurance or copays.
The minimum deductible varies each year. According to the IRS definition of HDHP in 2022, it is one with a deductible of nothing less than $2,800 for a family and $1,400 for an individual. The deductible is the amount you have to pay out of pocket on an insurance claim before your coverage is activated. When you pay that part of the claim, then your insurance company pays the rest.
Typically, healthy people who only need coverage for serious emergencies are best-suited to high deductible plans. Someone who’s higher-income might also opt for these plans specifically because they give them access to tax-advantaged Health Savings Accounts.
HSAs are exclusively available to people covered by an HDHP. You can’t have any other type of health insurance for qualification.
With an HSA, you make regular contributions to the account, or your employer might. The funds aren’t subject to federal income taxes when you deposit money or withdraw it. You use the funds to cover qualified medical expenses your HDHP doesn’t cover. These expenses can include deductibles, copays, prescription drugs, vision care, and psychiatric treatments.
Unlike a flexible spending account or FSA, the contributions you make to an HSA don’t have to be withdrawn or spent during the tax year they’re deposited. Unused contributions can be rolled over indefinitely.
Is an HSA Right For You?
Both high-deductible health plans and HSAs were created with the primary purpose of helping to manage health care costs and keep them under control. It creates a kind of awareness about your health care spending that encourages you to spend health care dollars more wisely.
We talked about this above, but an HSA could be a good choice for you if you’re generally healthy and you want to put money aside for any future health care costs you might incur. If you’re near retirement, these accounts can also make sense because you can use the money you contribute to offset your medical expenses after retirement.
If you think you could need expensive medical treatments in the next year and you would face challenges in meeting a high deductible, this probably isn’t the right option for you.
How Do HSAs Work?
To qualify for an HSA, you have to meet the standards for eligibility outlined by the IRS. You must have a qualified HDHP and no other health coverage. You mustn’t be part of Medicare, and at the same time, you cannot be claimed as a dependent on anyone else’s tax return.
The max contribution for an HSA in 2022 is $3,650 for an individual. The max contribution for a family is $7,200. The annual limits on contributions apply to the total amount that both the employer and employee contribute.
If you’re 55 or older by the end of the tax year, you’re eligible to make catch-up contributions of an additional $1,000.
You can open an HSA at certain financial institutions, and contributions can only be made in cash. With employer-sponsored plans, funding can come from the employer and employee. A family member or any other person can also contribute.
Whether you are unemployed or self-employed, you have the privilege to contribute to an HSA so far you meet the eligibility requirements.
Pros and Cons of an HSA
Some of the advantages of an HSA include:
- If your employer makes contributions by payroll deduction to an HSA, they’re excluded from your taxable income.
- Your direct contributions to an HSA are completely tax-deductible from your income, and earnings are also tax-free. Excess contributions, however, incur a 6% tax and aren’t tax-deductible.
- You can use the money in an HSA to invest in stocks and other securities, leaving open the potential for higher returns.
The downsides of an HSA include:
- You need a high-deductible plan
- If you fund your own HSA, you should be able to set aside enough money to cover your deductible. If you don’t have the available cash to do this, your high deductible can be a financial burden.
- There are filing requirements that you have to follow, including rules for contributions, withdrawals, and distribution reporting.
Withdrawals
If you withdraw money from an HSA, it’s not taxed if the funds are used to pay for services the IRS views as qualified medical expenses. These qualified medical expenses were expanded by the CARES Act.
Insurance premiums don’t count unless the premiums are for Medicare or other health care coverage when you’re receiving health care continuation coverage, coverage when receiving unemployment compensation, or long-term care insurance.
The premiums you have to pay for Medicare supplemental coverage or Medigap policies aren’t qualified medical expenses.
If distributions are made from your HSA to pay for anything aside from qualified medical expenses, that amount is subject to an income tax and also a 20% tax penalty.
Once you turn 65, the penalty is eliminated, and you just have to pay income tax on your withdrawals that are non-qualified. HSAs are a good tax-advantaged savings tool, as long as they would work well in your particular situation.
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