Deciding on health care coverage is complicated. Is the prescription you take covered? What about your favorite doctor? There’s also a seemingly endless amount of acronyms. For example, do you know the difference between an FSA and an HSA? What you should know is that an HSA can be used to save you money on health-care costs and can also be used to reduce your yearly income tax burden.
What Is a Health Savings Account?
HealthCare.gov defines a health savings account (HSA) as a specific type of savings account that allows users to save pre-tax money to pay for qualified out-of-pocket medical costs. These out-of-pocket costs can include copays, deductibles, some procedures not covered by your medical insurance coverage, eyeglasses, dental work, and more. Although not everyone is eligible for an HSA, those who are can experience significant savings due to the tax advantages of HSAs.
Money deposited into an HSA is tax-deductible, meaning that it will reduce your total amount of taxable income. Not only is the money placed in an HSA tax-free, but so are any earnings on it: Like with some retirement accounts, some HSAs allow account owners to invest their funds. Money withdrawn from the account for qualified medical expenses isn’t taxed, no matter the age of the account holder. The money doesn’t have to be spent on the person named on the account, either, it can also be spent on their spouse, child, or other dependents. However, money taken for the account for non-qualified medical expenses is subject to taxation as well as a 20% penalty if the account owner is younger than 65 (those older than 65 can withdraw money for any reason and only have to pay income tax on the withdrawal).
While plans like individual retirement accounts (IRAs) and Roth IRAs are subject to income limitations, there are no limits regarding income for HSAs, so those in all tax brackets can take advantage of the tax savings offered by HSAs. Many people use them as tax-advantaged IRAs to supplement their other retirement accounts. However, your eligibility is determined by what kind of health insurance you have. Only those with high-deductible medical insurance plans are eligible to open an HSA. As of 2022, high-deductible plans are defined as those with a minimum of a $1,400 deductible for an individual plan and a minimum of a $2,800 deductible for a family plan. Plans on the health exchange and those offered by employers are marked as HSA-eligible if they meet these qualifications. People who are eligible for an HSA for one year and then move to a lower-deductible plan are no longer allowed to contribute to their HSA, but they can maintain the account and use the money for qualified medical expenses at their discretion.
Invest for Your Future
Have you ever had an FSA? Also known as cafeteria plans, these plans are use it or lose it: Money put in one year has to be used within that year or, at the very latest, early in the next year. FSAs are also tied to employers. HSAs are different. For one, they are portable. If you change jobs, your HSA follows you (even if you are no longer eligible to deposit money into it). There also is no use-it-or-lose-it provision with HSAs. You can withdraw the money for qualified medical costs, or you can choose to pay those costs out of pocket and treat your HSA as an investment vehicle.
How do HSAs work as an investment in your future? Unlike FSAs, but like retirement accounts, you can often invest the money you deposit into your HSA in a variety of ways. Your deposits and any gains won’t be taxed as long as the money is used for medical costs when it’s withdrawn. Typically, you must achieve a minimum balance in your HSA before you are eligible to start investing the money. The investment vehicles offered differ by each financial institution, but usually, you can choose to invest in ETFs, mutual funds, or individual stocks.
Why do people choose to use their HSAs as an investment in their future instead of as a way to pay current medical expenses? Typically, we spend more on health-related costs as we age. Investing now in an HSA means you’ll have enough to pay for health care, including long-term care costs, in retirement. HSAs can also be treated as an emergency savings account for health-related costs. One-time costly events, like childbirth, or unexpected medical emergencies can be covered with funds saved in an HSA over a long period of time.
There are limitations to how much people can deposit into their HSAs annually. In 2021, the individual limit was $3,600 and the family limit was $7,200. Those 55 and older were also allowed to contribute an extra $1,000 during the year.
HSAs do have limitations on what’s considered a qualified medical expense. Qualified expenses include:
- Treatment for alcoholism and drug addiction
- Ambulance rides
- Artificial teeth (dentures)
- Chiropractic visits
- Cosmetic surgery (if related to disease or trauma)
- Dental treatment (including X-rays, fillings, braces, caps, extractions, implants, etc.)
- Eyeglasses (including exams and contacts)
- Eye surgeries (cataract and laser surgery included)
- Hearing aids (and batteries)
- Operations/surgery (excluding elective plastic surgery)
- Some over-the-counter medications
- Physical therapy
- Prescription drugs
- Long-term care
However, the following medical expenses are not considered qualified expenses:
- Paying for future care
- Money reimbursed by your health insurance company or FSA
- Babysitting services
- Plastic surgery
- Hair removal
- Funeral costs
- Transportation costs
- Fitness club expenses
- Help around the house
- Elective massage treatments
- Maternity clothing
- Toothbrushes, toothpaste, soap, and other personal care items
- Teeth whitening
- Weight-loss support (unless there is an underlying disease such as diabetes)
HSA accounts can have monthly maintenance fees as well as fees for using the debit cards and/or checks. It can also sometimes be hard to predict how much money you’ll need to save, and not everyone can afford to save the maximum allowed amount each year. It’s very difficult for older people, especially, to save enough money to properly prepare for their health expenses during retirement. And some people prioritize growing their HSA contributions so much that they delay getting needed health care because they don’t want to disturb their investments. Although HSAs have more freedoms than some other kinds of accounts, they still tie your money up. Still, an HSA is an excellent way for many people to save money on their tax bills while also investing for future health-care costs.