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What is a health savings account?

A doctor's visit.
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A health savings account, or HSA, is a tax-advantaged savings account for paying medical expenses that is available to consumers with high-deductible health insurance plans. Unlike a flexible spending account, an HSA has no deadline for spending the funds. It can be stashed away for health care costs in retirement.

Here’s what else you need to know about health savings accounts.

How an HSA works

The tax advantages of an HSA are available only if it is used to pay qualified out-of-pocket medical expenses such as payments for doctor’s office visits, prescriptions, ambulance service, eyeglasses and more. The IRS has a list of qualifying medical expenses.

The federal government sets the ceilings for out-of-pocket medical expenses. For 2022, the most an insured individual can be required to pay out of pocket is $7,050; the limit is $14,100 for a family. Once the insured party has met the out-of-pocket maximum, the insurance company must cover the rest.

HSAs generally come with a debit card or checks to make paying for medical expenses easy and straightforward.

HSA funds roll over year after year. There are no required minimum distributions or withdrawal deadlines. Any money you put into your HSA stays there until you use it.

HSAs are also portable. If you change jobs or health insurance plans, your HSA goes with you.

If you are 65 or older and enrolled in Medicare, you can no longer make contributions to an HSA, but you can still use the money you’ve built up in the account to pay out-of-pocket medical expenses.

How to get an HSA

To qualify for an HSA, you must be enrolled in a high-deductible health insurance plan and have no other health insurance. You cannot be claimed as a dependent on someone else’s tax return nor eligible for Medicare.

The IRS sets the thresholds for what is considered a high-deductible health plan. For 2022, a qualifying insurance plan has a deductible of at least $1,400 for an individual or $2,800 for a family.

Not all plans with a high deductible are eligible, so when shopping for an HSA  look for plans that say “HSA-eligible.”

Your employer may offer HSA-eligible insurance plans. You can also find financial institutions that offer these accounts. BMO Harris Bank and Bank of America offer HSAs, for example. Applying for an HSA at a bank is similar to opening a savings account. You must fill out an application and provide basic information, such as your Social Security number, date of birth, physical address, phone number and a valid email address.

You can use HealthCare.gov to find HSA-eligible plans and websites like HSASearch to compare providers.

Contribution limits

With an HSA, you can decide how much you want to contribute, up to the annual limits set by the IRS. If you have an HSA through your employer, you can set up automatic contributions to the account from your paycheck.

Your contribution to your HSA depends on your personal financial situation. Ideally, you would contribute the maximum allowed each year by the IRS, says Juli Erhart-Graves, certified financial planner and president of Worley Erhart-Graves in Indianapolis.

In 2022, the maximum allowable HSA contribution is $3,650 for individuals and $7,300 for families. If you are 55 or older at the end of the tax year, you can contribute an additional $1,000.

If you can’t afford to contribute the maximum, try to contribute the amount you expect to pay for qualified medical expenses for the year. “Since you have to pay the medical expenses anyway, send them through the HSA so you don’t have to pay taxes on those amounts,” Erhart-Graves says.

Advantages of an HSA

There are a number of benefits to an HSA, with tax perks being among the most significant:

  • Contributions to an HSA are tax-deductible, or pre-tax if made through a payroll deduction. This means they are not included in your annual gross income and are not subject to federal income taxes.
  • If you invest the HSA, earnings are tax-free.
  • Withdrawals are tax-free as long as they’re used to cover qualified medical expenses.
  • You can use HSA funds now and in your retirement years.
  • You, an employer, a relative or others can contribute to your HSA.
  • There are no time constraints for spending the funds. If you have money left in your HSA at the end of the year, it rolls over so you can use it the following year.
  • If you can afford to pay out of pocket for your medical expenses each year, you can still make the maximum contribution to your HSA and build up the account for use in the future. “It’s important that you have the receipts to match up to a distribution, but this gives you a tax-free distribution, which can be very helpful in retirement years,” Erhart-Graves says.
  • Your HSA is portable, so even if you change employers or insurance companies, you can still use the funds for qualified medical expenses.
  • The list of medical expenses that qualify for HSA spending is extensive — everything from eyeglasses and hearing aids to bandages and birth control pills.
  • HSAs can be invested in mutual funds, stocks and other investment products.
  • HSAs are passed on to your designated beneficiary when you die. A spouse can inherit the money tax free.

Tax advantages

The tax benefits are the best thing about an HSA, which is more tax-advantaged than a 401(k). HSAs have a threefold tax benefit:

  • Contributions made to an HSA aren’t subject to federal taxes.
  • Interest earned by investing in an HSA isn’t taxable.
  • Distributions from an HSA are tax-free, as long as they used to pay for qualifying medical expenses.

Disadvantages of an HSA

Despite its big tax advantages, an HSA does have a few drawbacks.

  • It can only be spent on qualifying medical expenses.
  • If HSA funds are used for anything other than qualifying medical expenses, you’ll owe taxes on that money, plus a 20 percent tax penalty. After age 65, you’ll owe the taxes but not the penalty.
  • Some HSA providers charge account fees, such as monthly fees or per-transaction fees. You may be charged for account overdrafts or deposits that don’t clear. Ask your HSA custodian for a complete fee schedule.
  • You must be enrolled in a high-deductible health plan to qualify for an HSA.

What happens to an HSA if you change jobs

HSAs are portable accounts. So, if you switch insurance, change jobs or retire, you’ll still have access to your HSA. “It’s yours. You can move it to a different bank or custodian if you want,” Erhart-Graves says.

You can also keep contributing to it as long as you meet the federal rules for eligibility.

If you no longer have medical insurance that qualifies for an HSA, your existing HSA sits there until you use it, move it or invest it, Erhart-Graves says.

How to invest for an HSA

All or part of the funds in health savings accounts can be invested in mutual funds, stocks, bonds and other investment products. It’s a tax-free way to grow your HSA to pay for medical expenses in retirement.

But investing in risky products may mean that your money is not there when you need it to pay for health care. Fortunately, you can also put your money into safe but lower-yielding investments such as a money market fund.

The choice of HSA investment tools differs among plan custodians. Some HSAs are merely savings accounts that do not earn much interest. Shop around for a plan with quality investment options and low costs.

Remember that FDIC-insured savings accounts are protected up to $250,000, but stocks and other investments don’t have that safeguard.

HSA vs. flexible spending account (FSA)

HSAs and FSAs have similarities and differences. Here is a comparison of the two to help you decide which option is more suited to your needs and goals.

  • Contributions to both HSAs and FSAs are tax-free, up to the contribution limits.
  • Distributions from HSAs and FSAs are tax-free as long as the money is spent on qualifying medical costs.
  • HSAs have more growth potential than FSAs because they can be invested and the earnings are tax-free.
  • You must have a high-deductible health plan to qualify for an HSA. You can have an FSA with a traditional health plan.
  • Contribution limits to HSAs are higher than FSAs.
  • Unspent HSA funds roll over year after year. If you don’t spend your FSA, you forfeit those funds to your employer, though some employers do have grace periods or allow you to carry over a certain amount.
  • An HSA is portable if you change jobs, insurance plans or retire. An FSA isn’t.
  • You can change your contribution amount to an HSA at any time, but FSA contribution decisions are usually confined to the annual enrollment period.
  • Both accounts often come with a debit card to make paying for and tracking medical expenses easier.

Bottom line

If you have a high-deductible health plan, getting a health savings account is a very smart financial move. The tax benefits are big, and it’s a great way to build up money for health care costs in retirement.

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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