A health savings account (HSA) is essentially a personal savings account that can be used only for medical expenses. To be eligible, you must be enrolled in a high-deductible health plan (HDHP). HSAs have substantial tax advantages, so much so that some use them as retirement plans, alongside their 401(k) or IRA accounts.
Contributions to an HSA are made with pretax dollars. This means that you won’t pay income tax on the money that you put directly into your HSA and you'll save on income taxes for the year.
On the other hand, the money that you put into your HSA is expensive to access once it’s already in the account if it is not used properly. You’ll owe income taxes plus a 20% penalty if you withdraw funds from your HSA for non-qualified expenses before you turn age 65.
- The health savings account (HSA) helps people with high-deductible health insurance plans cover their out-of-pocket medical costs.
- Contributions to HSAs aren’t subject to federal income tax, and the earnings in the account grow tax-free.
- Unspent money in an HSA rolls over at the end of the year, so it’s available for future health expenses. This is unlike flexible spending accounts (FSAs), which are “use it or lose it.”
- You’ll owe income taxes plus a 20% penalty if you withdraw funds from your HSA for non-qualified expenses before you turn age 65. Once you’re 65, you’ll owe taxes but not the penalty.
- High-deductible health plans (HDHPs), which are a requirement for HSAs, aren’t always the best option for consumers, especially for those who have significant healthcare expenses.
Pros And Cons Of A Health Savings Account
Understanding Health Savings Accounts (HSAs)
An HSA is a tax-exempt savings account that is available only to people who have high-deductible health insurance plans. The money can be used only to pay for qualified medical expenses. If the money is spent for any other purpose, the account holder has to pay income tax on the withdrawal plus a 20% tax penalty (unless the person is age 65 or older, in which case the penalty is waived).
Who Is Eligible for an HSA?
People with an HDHP can open an HSA. The two are usually paired together, so you’ll be offered an HSA when you take out a qualifying plan.
You must also meet the eligibility standards set out by the Internal Revenue Service (IRS). An eligible individual is someone who:
- Has a qualified HDHP
- Has no other health coverage
- Is not enrolled in Medicare
- Is not claimed as a dependent on someone else’s tax return
Is It Worth It to Have an HSA?
It can be worth it for the tax advantages alone. The money that you contribute to an HSA is tax-free, so you lower your tax bill by routing money that you can use for medical expenses through such an account. Your employer won’t withhold income taxes on this money.
On the downside, an HSA is open only to people with HDHPs, and a high-deductible plan is not for everyone. The financial benefit of an HDHP’s lower premium and higher deductible structure depends on your personal situation. Generally, healthy people with no ongoing issues that require regular treatment may find them adequate.
Does HSA Money Expire?
No. The money you put in your HSA has no expiration date and will stay in your account forever. This means that unspent money in an HSA rolls over at the end of the year and remains available for future health expenses.
This is unlike flexible spending accounts (FSAs), which are available to many through their employers but which are strictly “use it or lose it.”
What Can HSA Funds Be Used for?
Money that you withdraw from your HSA isn’t taxed as long as it is used for a qualified medical expense. The list of permitted expenses is quite long and includes deductibles, dental services, vision care, prescription drugs, co-pays, psychiatric treatments, and other qualified medical expenses not covered by a health insurance plan.
Insurance premiums don’t count as a qualified medical expense with some exceptions: the premiums are for Medicare or other healthcare coverage for people 65 or older; for healthcare continuation coverage (COBRA) while receiving unemployment compensation, or for long-term care insurance, subject to annually adjusted limits.
Premiums for Medicare supplemental or Medigap policies are not treated as qualified medical expenses.
If you use your HSA to pay for anything other than a qualified medical expense, that amount is subject to both income tax and an additional 20% tax penalty unless you are age 65 or older. In that case, you just have to pay income tax on the amount withdrawn.
Annual Contribution Limits
For 2022, the limit is $3,650 for individuals and $7,300 for family coverage for families plus an additional $1,000 catch-up contribution for anyone age 55 or older by the end of the tax year.
For 2023, the contribution limit is $3,850 for individuals and $7,750 for family coverage.
Advantages of HSAs
Access to an HSA is intended to take some of the stress out of unexpected health costs. But these accounts have other advantages.
Many Expenses Qualify
Eligible expenses include a wide range of medical, dental, and mental health services. They are explained in detail in IRS Publication 502, Medical and Dental Expenses.
Over-the-counter medications and menstrual products are now qualified HSA expenses. This is a result of the CARES Act passed in 2020.
Others Can Contribute
Contributions can come from you, your employer, a relative, or anyone else who wants to add to your HSA.
Employers choose whether or not to contribute. And, of course, it's not a factor for a self-employed person funding an HSA.
Contributions are made with pretax dollars through payroll deductions by your employer. In other words, your employer won’t withhold taxes on these dollars.
That means that the money is not included in your gross income and is not subject to federal income taxes. In most states, contributions are not subject to state income taxes.
Tax-Deductible After-Tax Contributions
If you make contributions with after-tax dollars, you can deduct the money from your gross income on your tax return, reducing your tax bill for the year. For example, if you’re an individual under the age of 55, your maximum allowed contribution is $3,650 in 2022 and to $3,850 in 2023.
So, if you deposit only $2,600 into your HSA through payroll deductions by the end of 2022, you may choose to deposit an additional $1,050 to further lower your tax liability. You generally have until the IRS tax filing deadline to contribute.
Withdrawals from your HSA are not subject to federal (and in most cases, state) taxes if you use them for qualified medical expenses.
Meanwhile, the balance in an HSA can be invested. You can purchase stocks, bonds, and other types of assets to boost your potential returns. Most financial advisors will strongly suggest conservative investments such as U.S. Treasury bonds. This account is, first of all, a nest egg for unexpected medical expenses.
Any interest or other earnings on the money in the account is tax free. Most HSAs earn a minimal amount of interest, less than 0.1%.
If you have money left in your HSA at the end of the year, it rolls over to the next year.
This is a big advantage over FSAs, which normally can only be carried over in an amount up to $550 or 2½ months into the following plan year.
The money in your HSA remains available for future qualified medical expenses even if you change health insurance plans, leave for a different employer, or retire.
Essentially, your HSA is a bank account in your name, and you decide how and when to use the funds.
HDHPs are required to set a minimum deductible and a maximum for out-of-pocket costs.
- In 2022, the minimum deductible is $1,400 for an individual and $2,800 for a family. The maximum for out-of-pocket costs is $7,050 for individuals and $14,100 for families.
- In 2023, the deductible must be at least $1,500 for an individual and $3,000 for a family while out-of-pocket costs are limited to $7,500 for individuals and $15,000 for families.
Most HSAs issue a debit card so you can pay for prescription medications and other eligible expenses. 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 HSA debit card. You can also reimburse yourself out of an HSA if you have paid a medical bill with another form of payment.
Disadvantages of HSAs
If you qualify for an HSA, there are some disadvantages to consider.
An HDHP, which you are required to have to qualify for an HSA, can put a greater financial burden on you than other types of health insurance. Even though you will pay less in premiums each month, 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.
This is something to consider for anyone who knows they will have hefty medical bills in a particular plan year.
The deductibles for HDHPs are often significantly higher than the minimums required and can be as high as the maximum out-of-pocket costs allowed.
Pressure to Save
Some people may be reluctant to seek healthcare when they need it because they don’t want to spend the money in their HSA accounts.
Taxes and Penalties
If you withdraw funds for non-qualified expenses before you turn age 65, you’ll owe income taxes on the money plus a 20% penalty. Once you’re 65, you’ll owe taxes but not the penalty.
This can be hard on a person who faces an unexpected expense that is anything but medical. They have saved the money but can't access it without taking a financial hit.
You must keep receipts to prove that your withdrawals were used for qualified health expenses. This will be necessary if you are audited by the IRS.
Some HSAs charge a monthly maintenance fee or a per-transaction fee, which varies by institution. While typically not very high, the fees are almost certainly higher than any interest that the account may earn and cut into your bottom line.
Sometimes these fees are waived if you maintain a certain minimum balance.
What Is the Main Benefit of a Health Savings Account (HSA)?
Having a health savings account alleviates some of the stress of unexpected and unpredictable medical expenses. Better yet, the money you save in this account is tax-free.
You can claim a deduction on your tax return for your HSA contributions regardless of whether or not you itemize deductions. You can claim a tax deduction even if someone other than your employer makes a contribution to your HSA.
If your employer contributes to your HSA, these contributions are excluded from your gross income. This includes contributions that you receive via a cafeteria plan.
Withdrawals from your HSA that are used for medical expenses are not subject to taxation.
You do not even pay taxes on the earnings and interest you receive from the assets you hold in your HSA.
What Is the Main Downside of an HSA?
The main downside of an HSA is that you must have a high-deductible health insurance plan to get one. A health insurance deductible is the amount of money you must pay out of pocket each year before your insurance plan benefits begin.
You will be responsible for coming up with the cash to pay for your deductible before your insurance plan begins paying your healthcare costs. You’ll need to pay for visits to the doctor, medical procedures, and prescriptions until you satisfy your deductible.
In 2022, you’ll need to pay a deductible of at least $1,400 for an individual and $2,800 for a family. The figures for 2023 are $1,500 and $3,000.
Some plans have higher deductibles, and you’ll also need to factor in additional costs such as co-pays.
If you anticipate needing to use your health insurance for expensive procedures—such as treatment for a chronic illness or surgery—you’ll need to pay the costs until you satisfy your deductible.
If you would find this financially difficult, you might want to look at different types of healthcare plans that offer a lower deductible. That means forgoing access to an HSA.
What Are the Benefits of a High-Deductible Insurance Plan With an HSA?
The main benefits of a high-deductible medical plan with an HSA are tax savings, the ability to cover some expenses that your insurance doesn’t, the ability to have others contribute to your account, and the convenience of using the account to pay for healthcare expenses.
Another benefit of an HSA is the portability of the account. You roll over any funds left in your account at the end of the year to the following year.
The money is yours forever. You can allow it to grow in your HSA. Some people use their HSA as part of their retirement planning strategy.
How Can I Check the Balance on My HSA?
Most financial institutions that provide HSAs offer their customers various ways to check their account balances. These include:
- Online access. Your HSA provider will give you access to your account online, and you can log in just as you would for an online bank or brokerage service. You’ll be able to log in to view your account statements, balance, and transactions.
- Printed statement. Some people prefer to have a printed copy mailed to them. If you choose this option, your balance and recent transactions will be included in your statement.
- Phone app. Check to see if your HSA provider offers an app that allows you to check your account balance from your phone.
- Customer service. Your HSA provider will have a customer service number that you can call for assistance.
The Bottom Line
For those who choose high-deductible health plans (HDHPs), an HSA has real advantages. It can offset your medical costs, reduce your taxes, and give you a long-term tax-advantaged savings account.
But an HDHP isn't the best option for everyone, and having one is the only way to get access to an HSA account.