Do you need a health savings account? Here are the pros and cons

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A health savings account, or HSA, allows anyone with a qualifying high-deductible health plan to set aside pretax funds to pay for approved medical expenses. Your money is held by a qualified HSA trustee (typically a bank, credit union or similar entity) to be used to pay for, or reimburse yourself for, these approved expenses.

Who typically uses a health savings account?

People with a qualifying high-deductible health plan, or HDHP, are most likely to use a health savings account.

A health insurance plan is considered a HDHP if it has a:

  • Minimum deductible of $1,400 for individual coverage and $2,800 for family coverage
  • Maximum out-of-pocket cost of $7,000 for individual coverage and $14,000 for family coverage

How health savings accounts work

Not all plans may qualify as a HDHP so check with your employer or insurance agent if you are not sure. Most employers have selected a HSA trustee but even if they have, you can select your own. Different trustees charge different fees, offer varying interest rates and investment options and may offer a variety of services such as receipt storage and the ability to transfer funds between your HSA and checking or savings accounts. 

For 2021, the maximum HSA contribution is $3,600 for an individual and $7,200 for family coverage. Employees who reach age 55 by the end of the tax year can contribute an additional $1,000 as a “catch up” provision.

If these contributions are deducted from your paycheck by your employer, and remitted to a trustee, these funds are pre-tax, reducing your annual income by the amount you defer. In other words, you pay a lower amount to Uncle Sam and more money stays in your pocket. Accrued interest on the funds you have in this type of account are not taxable. When your balance gets large enough, most trustees allow you to invest your funds in mutual funds, bonds or stocks. 

HSA contributions can be reduced and added to throughout the year. The IRS delayed until May 17, 2021 the deadline to make prior year contributions so if you did not max out your 2020 contributions, you still have time to do so.

What are the advantages of a health savings account?

There are many advantages to using a health savings account, including:

  • Typically there is no initial deposit required to open an account: HSAs are portable and you can change trustees once every 12 months. Bank and credit union HSA accounts are insured up to $250,000.
  • Your employer or other eligible family member can contribute to your HSA although the maximum contribution limits still apply. Employer contributions are not counted as income and you can claim a tax deduction for contributions you make and for contributions a family member makes.
  • Funds can be used to pay for qualified medical expenses for a spouse and dependent children even if they are not covered under your health plan.
  • After retirement, funds can be used to pay for Medicare or Medicare Advantage plan premiums (but not Medigap policies).
  • After age 65, withdrawal of funds for non-medical uses avoids the 20 percent penalty although these withdrawals are considered as taxable income. Some people have used their HSA nest egg to purchase investment property.
  • Funds can be transferred out of your investment portion of your account (typically mutual funds or stocks) as needed to pay for approved medical expenses.
  • For those not working, you can still contribute to your HSA account. Although these contributions won’t be pre-tax, they can be deducted on your tax return.

What are the disadvantages of a health savings account?

It’s important to consider the potential disadvantages of using a health savings account.

  • Withdrawal of funds for non-medical purposes prior to age 65 are considered taxable income and a 20 percent penalty is also assessed by the IRS.
  • Some big box stores and other merchants do not accept HSA cards and you will have to obtain reimbursement from your HSA trustee.
  • If you are claimed as a dependent on someone else’s tax return, you are not eligible for an HSA.
  • Expenses can be audited by the IRS so you will have to keep receipts for all purchases.
  • Interest rates on HSA accounts are low and some trustees charge a monthly fee if your balance drops below a certain threshold.
  • If you don’t stop contributing to your HSA six months before you apply for social security benefits, tax penalties may apply.
  • After an individual has attained age 65 (Medicare eligibility age), additional contributions (including catch up contributions) can no longer be made, even if still employed.
  • Minimum balance requirements may apply before you can invest; investment options may be limited and investments are not insured.

What are some examples of qualified or approved medical expenses?

Thousands of items are eligible.

In addition to health plan co-payments, dental work and orthodontia, eyeglasses, contact lenses and prescriptions are included. Massages, yoga classes and gym memberships are also eligible if you have a letter of Medical Necessity from a doctor prior to receiving the service.

Thanks to the CARES Act, over-the-counter medications and feminine hygiene products are now eligible expenses. The IRS announced on March 26, 2021 that face masks, hand sanitizer and sanitizing wipes for the purpose of preventing the spread of COVID-19 have been added as an approved medical expense to be paid or reimbursed through a HSA.

Here are some other items you can use HSA funds for:

  • To reimburse yourself for mileage to a doctor or medical facility and to pay for lodging if receiving medical care in another city necessitating an overnight stay.
  • Post-tax Cobra and LTC (Long Term Care) policy premiums.

HSA history

Here’s a bit of background on HSAs: HSAs were first used in 2004 and were patterned after rules governing IRAs as they were designed as a long-term savings vehicle in addition to defraying medical expenses. 

According to 2018 statistics from the Employee Benefit Research Institute (EBRI), nearly three in 10 employees had access to HSAs and 71 percent of HSAs were opened since 2015. 

Bottom line

Setting aside pre-tax dollars for current and future medical expenses may be right for you. As HSA funds roll over from year to year allowing unspent funds to accumulate, they can add a high degree of financial peace of mind for your golden years when the cost of medical expenses not covered by insurance could be a huge financial concern.  If you find that you don’t need additional funds for medical expenses, you can always splurge on something you really want or leave it to the beneficiary of your choice.

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Written by
Karen Roberts
Contributing writer
Karen Roberts is a contributing writer for Bankrate. Karen writes about saving for retirement.