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

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A little girl gets a vaccination.
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A health savings account allows anyone with a qualifying high-deductible health plan to set aside pretax money to pay for approved medical expenses. The funds are held by an HSA trustee (a bank, credit union or other financial institution) until it is withdrawn to pay for certain health-care expenses.

Who typically uses a health savings account?

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

In 2022, the IRS considers a health insurance plan to be an HDHP if it has a:

  • Minimum deductible of at least $1,400 for an individual and $2,800 for family coverage
  • Maximum out-of-pocket cost of $7,050 for individual coverage and $14,100 for family coverage

How health savings accounts work

Check with your employer or insurance agent if you’re not sure whether your health plan is an HDHP. Most employers select their own HSA trustee, but an employee is free to choose a different trustee.

Fees, interest rates, investment options and extra services vary among trustees. Some offer helpful features such as electronic storage of your health care receipts and letting you transfer funds between your HSA and checking or savings accounts to make paying medical bills easier.

For 2022, the HSA contribution limit is $3,650 for an individual and $7,300 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 your HSA contributions are deducted from your paycheck, you reduce your taxable income by the amount you contribute. The interest accrued on the HSA account also isn’t taxable. With a big enough account balance, most trustees allow you to invest HSA funds in mutual funds, bonds or stocks.

Advantages of a health savings account

There are several advantages to opening a health savings account.

Tax benefits

HSAs have more tax advantages than 401(k) accounts. If you contribute by paycheck deduction, those funds are pretax. Your employer, a relative or anyone else can contribute, and those funds also are tax-free. Withdrawals aren’t taxable as long as the money is used to pay for qualifying health-care expenses.

You can keep contributing to an HSA if you’re not working and deduct them on your federal tax return.

At age 65, funds used to pay for nonmedical expenses are taxable, but there is no 20 percent tax penalty. Some people use their HSA nest egg to buy investment property.

No opening deposit

Typically, there is no minimum deposit required to open an HSA account.

Balance rolls over

Unlike a flexible spending account (FSA), which must be spent by the end of the plan year,  HSA balances roll over. There is no time limit for spending the funds.

Investment opportunities

An HSA allows you to invest your funds in stocks, bonds and other instruments. Earnings are tax-free. Some trustees require a specific minimum balance before they allow you to invest.

Portability

HSAs are portable. You own the account. If you leave your job, you can take the HSA with you.

Insurance-eligible

HSAs held in federally insured banks and credit unions are insured up to $250,000.

Benefits to family

HSA funds can be used to pay for qualified medical expenses for your spouse and dependent children, even if they are not covered under your HDHP.

Offset Medicare premiums

After retirement, funds can be used to pay for Medicare or Medicare Advantage plan premiums (but not Medigap policies).

Easy transfers

HSA funds invested in mutual funds or stocks can be transferred to pay for approved medical expenses, as needed.

Disadvantages of a health savings account

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

Potential tax drawbacks

Prior to age 65, HSA funds withdrawn to pay for nonmedical expenses are considered taxable income. The IRS also levies a 20 percent penalty.

Expenses can be audited by the IRS so you should keep receipts for all payments made with HSA funds.

If you don’t stop contributing to your HSA six months before you apply for Social Security benefits, tax penalties may apply.

Not everyone eligible

If you are claimed as a dependent on someone else’s tax return, you’re ineligible for an HSA.

For HDHPs only

Only those with high-deductible health plans qualify for an HSA. Meeting a high insurance deductible might be a hardship.

Rejection of HSA cards

Not all stores accept HSA debit cards, so you may have to pay for your expenses out of pocket and get reimbursed by your HSA trustee.

Weak earnings and investment limits

Interest rates on HSA accounts are low and some trustees charge a monthly fee if your balance drops below a certain threshold.

Minimum balance requirements may apply before you can invest; investment options may be limited and investments are not insured.

No more contributions

Once an individual reaches age 65 (the age for Medicare eligibility), additional contributions (including catch-up contributions) can no longer be made, even if still employed.

Examples of qualified medical expenses

The IRS includes many items on its list of tax-deductible medical expenses.

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.

The Coronavirus Aid, Relief and Economic Security (CARES) Act expanded the list of eligible health-care expenses to include over-the-counter medications and feminine hygiene products. Face masks, hand sanitizer and sanitizing wipes also are eligible.

Among other things, you can also use HSA funds:

  • To reimburse yourself for mileage to a doctor or medical facility and to pay for lodging if receiving medical care in another city that necessitates an overnight stay.
  • To pay post-tax COBRA and long-term care policy premiums.

HSA history

HSAs were established by federal law and first opened in January 2004. Like individual retirement accounts, they were designed as a long-term savings vehicle and a way to defray medical expenses.

The average year-end HSA balance was $2,672, higher than the average beginning-of-year balance of $2,187, according to 2019 statistics from the Employee Benefit Research Institute, which analyzed 10 million HSA accounts.

EBRI also found that only 7 percent of HSAs had assets in stocks, bonds or other investments.

Is an HSA right for you?

Savers who want to set aside money for health-care costs may have access to an HSA or FSA — or possibly both, depending on an employer’s benefits plan. Both offer tax advantages, so compare the two accounts before making a choice.

HSAs have fewer limitations and more tax advantages than FSAs. As HSA funds roll over and continue to grow, they can benefit you in your golden years when many seniors worry about incurring medical expenses that aren’t covered by insurance.

If you don’t need additional funds for medical expenses, you can spend your HSA on a dream vacation or something else you really want. Just remember that HSA money used for anything except qualifying medical expenses is taxable, even in retirement.

Written by
Libby Wells
Contributing writer
Libby Wells covers banking and deposit products. She has more than 30 years’ experience as a writer and editor for newspapers, magazines and online publications.
Edited by
Wealth editor