Center for a Secure Retirement
What Is an HSA (Health Savings Account)?

What Is an HSA (Health Savings Account)?

Most health insurance offerings won't cover 100% of your medical bills and associated expenses. To help people prepare for out-of-pocket costs, the government created health savings accounts (HSAs), which can allow you to put aside pretax income for future health care expenses, give you a tax break and leave you with money for your bills.

Here's a deeper look at HSAs and how these accounts work.

What Is an HSA?

An HSA is an account used for health care expenses. It's important to note that an HSA is not a health insurance plan and will not pay your medical bills directly. Instead, these accounts partner with a health insurance plan so you can save money on expenses outside of your policy.

Health insurance plans typically leave you paying some bills out of pocket, such as deductibles and coinsurance. An HSA provides a way to prepare for them. You could also use the account balance for other health care expenses, such as dental work, long-term care or medical supplies.

How Does an HSA Work?

An HSA lets you put money aside in your account during the year. If you have a plan through your work, you can make contributions directly from your paycheck. If you have one outside of work, you would likely transfer funds over from your bank account.

For 2021, you can deposit up to $3,600 per year into an HSA as an individual and up to $7,200 per year if you have family coverage. You can keep your HSA funds in cash or invest in funds of stocks, bonds, commodities or other assets to grow for the future.

If you have an eligible health care expense, your HSA will cover it. Your HSA provider may give you a debit card or checks that you can use to pay the expenses directly, or you might pay the bill out of pocket and then get reimbursed for the charges through your HSA after proving the purchase with receipts.

What Are Some of the Tax Advantages?

An HSA offers several major tax benefits. First, you fund these accounts with pretax dollars, which means you don't owe income tax on what you put in. In other words, your contributions are tax-deductible. If your employer adds money to your account, you also don't have to pay income tax for those funds.

Second, when you invest your HSA savings, as long as you keep the money in the account, you won't owe taxes on your investment gains. This can help you earn a higher after-tax investment return than a regular brokerage or bank account, where you owe taxes on your earnings each year even if you reinvest.

Last, when you spend your HSA funds on eligible health care expenses, you will not owe tax on the withdrawal. This means you avoid owing tax on both your income and your investment gains.

How Can You Use HSA Money?

You can spend HSA funds on IRS-qualified medical expenses for yourself, your spouse and your dependents. This includes out-of-pocket expenses for using your health insurance plan, such as deductibles, copayments and coinsurance. You can also use the HSA funds to pay for prescription drugs and dental or vision care, including the cost of glasses and contact lenses.

Additionally, medical supplies like bandages, crutches and wheelchairs are eligible as HSA expenses. With the passage of the 2020 CARES Act, HSA funds can now be used to buy over-the-counter medication like pain relievers and cold medicine as well as feminine care products.

While you typically cannot use an HSA to pay health insurance premiums, if you lose your job, you can use the money to pay for COBRA (to extend your work coverage) or for health insurance while you are on unemployment.

Once you turn 65, you can use your HSA to cover the Medicare Part B premium or to pay for Medicare Advantage and Medicare Part D prescription plans. If you still have a work-sponsored plan, you can pay for those premiums past age 65. However, you can't use HSA funds to pay for Medigap plans. You can also pay for long-term care insurance using funds from your HSA.

How Does HSA Spending Work Outside of Health Care?

You have the option to withdraw your HSA savings for something other than health care, but this can get expensive in terms of tax. If you make a withdrawal before you turn 65 for a non-qualified expense, you would owe income tax on the withdrawal plus an extra 20% penalty.

Once you turn 65, you can take money out for non-health-care reasons without owing the 20% penalty, so you'll only owe income tax. While this may not be as good a deal as spending on health care, it still works out the same tax-wise as taking money out of a 401(k) or traditional IRA.

Given their flexibility, HSAs can also help you develop your retirement savings. During your career, you would save money and spend whatever is needed on health care. Once you retire, you can use your HSA savings for health care or other retirement expenses.

How Do You Qualify for an HSA?

Not everyone can use an HSA. To be eligible, you must be enrolled in a high-deductible health plan (HDHP). For 2021, the government defines an HDHP as one with a deductible of at least $1,400 for an individual health insurance plan or at least $2,800 for a family plan. If you meet this condition, you can contribute to an HSA.

While HSA plans can be offered at work, they do not require an employer. Provided that you have an HDHP, you can open your own account as an individual outside of work.

If you qualified for an HSA in the past but are no longer in an HDHP, you can no longer add money to an HSA, but you can still keep and use your existing HSA funds. Also, because these plans don't require you to spend down your contributions by the end of the year, you can hold onto your balance for the future.

Should You Set Up an HSA?

If you have an HDHP and are eligible for an HSA, it can be worth it to get set up with one. Since you would need to pay a sizable deductible to use your health insurance plan, this could be a good way to prepare for that expense.

The main drawback of using an HSA is that once you put money in, it's expensive to take it out for non-health-care expenses because of the early withdrawal penalty. If you are still building up your general emergency fund or you may need cash for something else in the near future, be cautious about using an HSA.

Where Can You Set Up an HSA?

Your employer may offer an HSA as an employee benefit, but banks, credit unions, insurance companies and investment brokers offer them as well. There are also companies called HSA providers that specialize in these accounts.

While all HSAs follow the same tax rules, the fees, investments and account features could be different between accounts. Be sure to compare how much plans cost per year and look for one that will minimize your expenses. You should also check the investment options to make sure there are options you'd like to use.

Finally, consider convenience. Would you like something connected to your work or an existing bank/investment account? Does the HSA give you the features you want for spending your money, such as a debit card?

Given the rising cost of health care, an HSA can be an excellent way to save money that can be used to pay for health-related bills. Meet with your insurance agent for their advice on which account best fits your plans.

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