Health Savings Accounts (HSAs) were established in 2003, as part of the Medicare Prescription Drug, Improvement, and Modernization Act, and have since become an increasingly popular option for consumers and employers seeking to manage their healthcare costs.

MHSAs are used in combination with a High-Deductible Health Plan (HDHP). The HDHP trades relatively low premiums for relatively high deductibles. The Health Savings Account is used to help pay healthcare costs until the deductible is met.

Contributions to the HSA are tax deductible or, if made as payroll deductions, on a pre-tax basis. Withdrawals are tax-free provided they're used to pay for qualified medical expenses, which include those for dental and vision care—expenditures that many traditional health insurance plans may not cover.

Most HSAs issue a debit card, so you can pay for prescription medications and other eligible expenses right away. If you wait for a bill to come in the mail, you can call the billing center and make a payment over the phone using your debit card. 

Here, we answer questions you might have about Health Savings Accounts and how they work.

Key Takeaways

  • To enroll in an HSA, you must be covered under a High-Deductible Health Plan and not be enrolled in Medicare or on a spouse’s plan that lacks high deductibles.
  • For 2019, the maximum contribution amounts are $3,500 for individuals and $7,000 for family coverage. If you're 55 or older, you can add up to $1,000 more as a "catch-up" contribution.
  • The account can cover the costs of diagnoses, treatments, and preventive care. It can’t be used to pay for cosmetic procedures or products, or for most insurance premiums. 
  • HSAs have no use-it-or-lose-it provision. Any funds still in the plan at the end of the year can be rolled over indefinitely. 

Who Can Open a Health Savings Account?

According to federal guidelines, you can open and contribute to an HSA if you:

  • Are covered under a High-Deductible Health Plan
  • Are not covered by any other non-HDHP plan, such as that for a spouse (there are exceptions for certain plans with limited coverage, such as dental, vision and disability)
  • Are not enrolled in Medicare
  • Are not claimed as a dependent on someone else's tax return

What Qualifies as a High-Deductible Health Plan?

The IRS establishes guidelines each year that are adjusted for inflation. These are the limits for 2019.

2019 High-Deductible Health Plan Rules
  Individuals Families
Minimum Deductible $1,350 $2,700
Out-of-Pocket Maximum (includes deductibles, co-payments, co-insurance) $6,750 $13,500

Note that the out-of-pocket maximum includes deductibles, co-payments, and co-insurance—but not insurance premiums.

How Much Money Can I Contribute Each Year?

The IRS sets limits that determine the combined amount that you, your employer, and any other person can contribute to your HSA each year. For 2019, the maximum contribution amounts are $3,500 for individuals and $7,000 for family coverage. You can add up to $1,000 more as a "catch-up" contribution if you are age 55 or older at the end of the year.

How Can I Use the Money?

The funds in your HSA can be used to pay for qualified medical expenses incurred by you, your spouse, and your dependents. The IRS establishes what is and what is not a qualified medical expense, detailed in IRS Publication 502, Medical and Dental Expenses. Generally speaking, qualified expenses include amounts paid to diagnose, cure, mitigate, treat, or prevent disease, and to treat conditions that affect any part or function of the body.

However, you can't use it to pay insurance premiums, with the exception of those for supplementary Medicare coverage or long-term care insurance. Other ineligible expenses include the cost of toothpaste, toiletries, cosmetics, and most cosmetic surgery. You may not use it to pay for nicotine gum and nicotine patches that don't require a prescription. And the vacation you made to a healthier climate? Don't even think of tapping your HSA.

Is Preventive Care Covered by an HDHP?

Yes. Under current healthcare law, most plans must cover certain preventive care without a deductible or co-payment. So even though your plan has a high deductible, preventive care, such as annual physicals, well-child visits, and routine vaccinations are covered at no charge to you. Ask your health insurance provider for a current list of preventive services.

What Happens If I Use My HSA funds for a Non-Qualified Health Expense?

If you're 64 or younger and withdraw funds for a non-qualified expense, you'll owe taxes on the money (which will be taxed as income), plus a 20% penalty. If you're 65 or over, or disabled at any age, you'll owe taxes on the amount but be spared the penalty.

What If I don’t Use All the Money by the End of the Year?

Any money that is in your account at the end of the year remains in your account to pay for future qualified medical expenses. And it does so indefinitely. The account and its funds belong to you, and you retain ownership even if you change health insurance plans, change jobs, or retire.

How Can I Set Up an HSA?

You first need to enroll for an HDHP. If you take that step through your employer's human resources department, it should be able to advise you on creating an HSA. If HR can't, contact your health insurance company for help with setting up an HSA through its recommended bank..

Alternatively, ask your own bank or credit union if it offers HSAs and can provide you with enrollment information. You can also look online (try an Internet search for "HSA providers").

Once you select a bank, the enrollment process is fairly straightforward: You complete an application and fund the account. After that, you can begin to use the funds for qualified expenses.

The Bottom Line

HSAs, and their corresponding High-Deductible Health Plans, are worth investigating as a way of saving money on healthcare. If you're considering this option and currently have traditional, low-deductible health insurance, look at whether you would have saved money last year if you'd had an HSA instead of the plan you have now.

Keep in mind that you can use the account for more than expenses you incur under your main health insurance plan. For example, if your plan doesn't cover dental or vision care, and you have significant expenses in these areas, an HSA could be especially helpful.

Conversely, be aware that if you incur substantial health costs for standard medical care, the High-Deductible Health Plan required to open an HSA might not be the right choice for you. Even though you will pay less in premiums with the HDHP, it could be difficult—even with money in an HSA—to come up with the cash to meet the deductible for a costly medical procedure.

High-income families who can afford the deductibles out of other income can use the HSA that comes with an HDHP as another way to save $7,000 per year tax-free until retirement. That's why HSAs appeal to many high-income earners.