- A health savings account, or HSA, is a rare type of savings account as it has three tax advantages: pre-tax contributions, the ability for earnings to grow tax-free, and withdrawals for qualified medical expenses that aren’t taxed.
- HSA contribution limits for 2019 are $3,500 for individuals and $7,000 for families. For 2020, the limits are $3,550 and $7,100, respectively. You qualify for an HSA only if you’re enrolled in a high-deductible health plan.
- The open enrollment period, which is from Nov. 1 to Dec. 15, is a good time to consider whether a high-deductible health plan (HDHP) is right for you and your family.
You may have recently received an email from your employer that open enrollment season is approaching. You set your health insurance preferences last year, but you’re wondering if you should reassess your priorities. Are you on the optimal plan for you and your family? Are there any perks you aren’t taking advantage of? Are there ways you could be saving more money each month?
Perhaps you’re familiar with a health savings account, or HSA, but you’ve never opened one. An HSA can be a great way not only to save on medical expenses but also to invest money for your health expenses in retirement that can grow tax-free. Read on for everything you need to know about HSAs.
What Is an HSA?
An HSA is a savings account that is designed to help you save money to pay for healthcare and medical expenses tax-free. HSAs can be set up either by an individual or through an employer. They’re only available for people who are on a qualifying high-deductible health plan (HDHP), such as those offered under the Affordable Care Act. People on Medicare cannot qualify for an HSA.
An HSA works like this: At the start of your employer’s benefit plan year, you decide how much you’d like to contribute to your account. This amount will be evenly deducted each pay period. (You can always change your contribution amount within the plan year.) Your HSA funds can be spent on a range of qualified medical expenses, which include everything from medical exams and childbirth to physical therapy and birth control.
HSAs are a triple threat on the tax savings front — in a good way: Not only are contributions made pre-tax, but you can grow your money tax-free and make withdrawals for qualified expenses, which aren’t taxed.
One of the best parts about HSAs is that the funds can be rolled over once the plan year ends. They can also be rolled over if you leave the employer you started your HSA with. In short, HSA account funds are yours to keep regardless of where you work, or even if you stop working. The ability to roll over funds coupled with the myriad tax benefits — and the ability to invest your funds — means HSAs should be an important part of your retirement savings strategy.
Keep in mind that if your insurance provider doesn’t offer an HSA or you’re self-employed, you can open your own account through a different insurance provider. Since you are the owner of the account, your HSA funds can be passed to a beneficiary, like a spouse, in the event of death. Any other beneficiary aside from a spouse will have to pay taxes on the money.
What Are the Contribution Limits for an HSA?
HSAs have annual contribution limits, which increase each year. In 2019, HSA contribution limits are $3,500 per person and $7,000 per family. Next year, in 2020, HSA contribution limits are increasing to $3,550 per person and $7,100 per family.
There is also a catch-up contribution perk that allows those age 55 and older to contribute an extra $1,000 per year.
The “last-month rule” from the Internal Revenue Service (IRS) stipulates that if you became eligible for an HSA on the first day of the last month of the tax year (which is typically Dec. 1), you are considered eligible for the entire year. Your coverage will be exactly the same as if you were eligible for the entire year, according to the IRS, although you need to remain qualified for a thirteen month “testing period” thereafter.
If you weren’t eligible for the entire year or your coverage changed, the contribution limit could be different. This worksheet from the IRS can help you determine what your contribution limit is.
Why Should I Care About HSAs Right Now?
“Why should I care about HSA contributions right now?” you might be wondering.
Because HSA preferences can be changed at any time, it’s always important to keep them in mind. Plus, if it’s open enrollment season with your employer, you can switch to an HDHP so you’re eligible for an HSA.
As its name suggests, a high-deductible health plan features low monthly premiums and higher annual deductibles. You’ll pay more out-of-pocket expenses before your deductible is met, but you’ll save more money on your monthly premiums. A good rule of thumb is that you’re likely a good candidate for an HDHP if:
- You’re generally healthy.
- You don’t have a family history of health problems.
- You have funds to cover health care costs.
- You can afford to make sizable contributions to an HSA.
- You’re single, so you don’t have to consider the medical needs of any dependents.
What Is the Difference Between an HSA and an FSA?
In addition to HSAs, you’ve likely heard of flexible spending accounts, or FSAs. There are some similarities between the two accounts: Contributions for both accounts are pre-tax, and the qualified medical expenses are the same.
However, there are also marked differences you should be aware of. Here are the primary differences between the two accounts:
- An FSA is established by an employer (it can’t be opened by someone who is self-employed).
- The contribution limits for an FSA are slightly lower ($2,700 per individual for 2019).
- FSA funds can’t be rolled over — if you don’t use them, you lose them.
Another important differentiator is that you don’t have to report FSAs on your annual tax return, but you do need to report HSAs on Form 1040 or Form 1040NR.
What Are Considered Qualified Medical Expenses for an HSA?
Qualified medical expenses must be for the current year only. Although HSA funds cannot be spent on health insurance premiums, they can be spent on the following, all of which are considered HSA eligible expenses:
- General medical expenses (including dental and vision)
- Hospital services
- Chiropractor services
- Prescription medication
- Breast pumps
- Artificial limbs
- Long-term care premiums
- COBRA premiums
- Psychiatric care
- Substance abuse treatment
- Artificial teeth
- Physical therapy
- Forms of birth control (including condoms and implants)
- Fertility enhancement
If you don’t spend your maximum contribution, you can keep your balance. Unlike the FSA’s use-it-or-lose-it rule, HSA funds can be rolled over to the following year. Plus, there are no required withdrawals by a certain age like there are with IRAs or 401(k)s. You can use HSA funds well into old age.
However, there are stiff penalties for HSA withdrawals that aren’t considered qualified medical expenses. If you make a withdrawal that isn’t a qualified medical expense you could face a 20% IRS penalty — and you’ll have to pay income taxes on the withdrawal amount. After age 65, distributions aren’t subject to penalty but taxable if not used for qualified medical expenses.
A word of caution: It’s always a good idea to save any receipts and bills related to HSA expenses for three years in case you are audited by the IRS.
For more information on rules regarding HSA plans, you can consult this guide from the IRS.
How Can I Maximize My HSA Contributions?
As long as you qualify, funding your HSA each year is a smart move. Because of the various tax incentives, HSAs are a great way to provide your entire family coverage for medical events while also allowing you to grow your retirement savings.
It’s also wise to get guidance on how to invest your HSA funds. Investment options depend on the plan, but there are typically many, from mutual funds and ETFs to stocks and bonds. It’s important to match your investment goals with your short-term and long-term health care spending projections.
Take Control of Your Health and Finances
HSAs are not only a great vehicle for retirement savings, but they’re a good tool for protecting yourself against costly medical expenses. The countless tax advantages associated with HSAs are the government’s way of helping individuals take control of their health care expenses now and in the future.
By taking advantage of this tax perk, you’ll be able to rest assured knowing you’ve prioritized both your health care and your retirement savings. We’d call that a win-win.