Pros and Cons of a Health Savings Account (HSA)
A Health Savings Account (HSA) is like a personal savings account, but the money must be used only for qualified healthcare expenses. The account can be set up with you as the sole beneficiary, or for you plus your spouse and/or dependents. Established in 2003 as part of the Medicare Prescription Drug, Improvement and Modernization Act, HSAs allow people enrolled in a special health insurance plan called a High-Deductible Health Plan (HDHP) to pay for current healthcare expenses and save for future expenses on a tax-favored basis.
Here, we look at the eligibility requirements, pros and cons, and other important details about Health Savings Plans.
Being enrolled in an HDHP – the mandatory prerequisite for having a HSA – has pros and cons. While these plans have high deductibles, monthly premiums are typically much less than for plans with lower deductibles, which makes them appealing to people trying to minimize up-front costs associated with healthcare.
HDHPs are intended to cover serious illness or injury. With the exception of preventive care (such as annual physicals, child and adult immunizations, and screening services), your annual deductible must be met before any plan benefits are paid.
According to federal guidelines, you can open and contribute to an HSA if you are:
- Covered under a HDHP on the first day of the month
- Not covered by any other non-HDHP plan (with some exceptions for certain plans with limited coverage, such as dental, vision and disability)
- Not enrolled in Medicare
- Not claimed as a dependent on someone else's tax return
The IRS establishes guidelines (adjusted for inflation) for HSAs and HDHPs each year, based on individual and family coverage. For 2018 and 2019, all HDHPs must have a minimum deductible of $1,350 for individuals and $2,700 for families.
The out-of-pocket maximum (including deductibles, co-payments and coinsurance, but not premiums) rose from 2018 to 2019. Here are the numbers:
- 2018: $6,650 (self only), $13,300 (family)
- 2019: $6,750 (self only), $13,500 (family)
Health Savings Accounts offer a way to save for – and pay for – healthcare expenses. There are many advantages to having a Health Savings Account:
- Others can contribute to your HSA. Contributions can come from various sources, including you, your employer, a relative and anyone else who wants to add to your HSA.
- Pre-tax contributions. Contributions made through payroll deposits (through your employer) are typically made with pre-tax dollars, which means they are not subject to federal income taxes. In most states, contributions are not subject to state income taxes either. Your employer can also make contributions on your behalf, and the contribution is not included in your gross income.
- Tax-deductible contributions. Contributions made with after-tax dollars can be deducted from your gross income on your tax return, which means you may owe less tax at the end of the year.
- Tax-free withdrawals. Withdrawals from your HSA are not subject to federal (or in most cases, state) income taxes if they are used for qualified medical expenses.
- Earnings are tax-fee. Any interest or other earnings on the assets in the account are tax free.
- Funds roll over. If you have money left in your HSA at the end of the year, it rolls over to the next year.
- Portable. The money in your HSA remains available for future qualified medical expenses even if you change health insurance plans, change employers or retire. Funds left in your account continue to grow tax fee.
- Convenient. Most HSAs issue a debit card, so you can pay for your prescription medication and other 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. And, you can use the card at an ATM to access cash.
HSAs also have a several disadvantages:
- High-deductible requirement. Even though you are paying less in premiums each month, it can be difficult – even with money in an HSA – to come up with the cash to meet a high deductible.
- Unexpected healthcare costs. Your health care costs could exceed what you had planned for, and you may not have enough money saved in your HSA to cover expenses.
- Pressure to save. You may be reluctant to seek healthcare when you need it because you don't want to use the money in your HSA account.
- Taxes and penalties. If you withdraw funds for non-qualified expenses before you turn 65, you'll owe taxes on the money plus a 20% penalty. After age 65, you'll owe taxes but not the penalty.
- Recordkeeping. You have to keep your receipts to prove that withdrawals were used for qualified health expenses.
- Fees. Some HSAs charge a monthly maintenance fee or a per-transaction fee, which varies by institution. While typically not very high, the fees do cut into your bottom line. Sometimes these fees are waived if you maintain a certain minimum balance.
Hundreds of health expenses qualify for payment from an HSA. They are explained in detail in IRS Publication 502, Medical and Dental Expenses. Examples of qualified medical expenses include (but are not limited to):
- alcoholism treatment
- ambulance services
- contact lens supplies
- dental treatments
- diagnostic services
- doctor's fees
- eye exams, glasses and surgery
- fertility services
- guide dogs
- hearing aids and batteries
- hospital services
- lab fees
- prescription medications
- nursing services
- psychiatric care
- telephone equipment for the visually or hearing impaired
- therapy or counseling
Contributions to your HSA can be made any time during the calendar year and up to April 15 of following tax year. You can make regular contributions throughout the year, or make one lump-sum contribution whenever it's convenient.
The IRS sets contribution limits that determine how much you and/or your employer can contribute to your HSA each year. Here are the maximum contribution amounts:
- 2018: $3,450 (individuals), $6,900 (family coverage)
- 2019: $3,500 (individuals), $7,000 (families)
You can add up to $1,000 more as a "catch-up" contribution if you are age 55 or older by the end of your tax year.
Setting up a Health Savings Account
You must have a HDHP before you can sign up for a Health Savings Account. Once you have a HDHP, you can contact your health insurance company for details on setting up an HSA through its recommended bank, or you can select a financial institution on your own or through your employer's human resources department. Your local bank or credit union may offer HSAs and can provide you with enrollment information. You can also look online (try an internet search for "HSA providers").
Once you select a financial institution, the enrollment process is fairly quick. It includes completing an application and funding the account.
The Bottom Line
A Health Savings Account can be a great choice for people who wish to limit their upfront healthcare costs while saving for future expenses. HSAs go hand-in-hand with HDHPs, so monthly premiums are generally significantly less than if you had a low-deductible health plan. In addition, favorable tax treatment means you may owe less in taxes on your income tax return. What’s more, an HSA may allow you to pay in pre-tax dollars for items your employer’s other insurance options don’t cover, such as eyeglasses. Both healthy young people on budgets and affluent families who can afford the deductibles and easily set aside the $7,000 yearly maximum in a tax-advantaged HSA may find these accounts especially beneficial.
That said, HSAs aren't ideal for everyone. If having a high deductible seems too risky to you – or if you anticipate having significant healthcare expenses – a plan with a lower deductible and lower co-pays might make more sense.
Before making any decisions, compare your options and take a close look at the associated cost elements (e.g., monthly premiums, deductible, co-pays and coinsurance). Also compare an HSA to a Flexible Spending Account (FSA), which is another way to use pre-tax dollars to pay for health expenses. For example, you don't need to have a high-deductible health plan to have an FSA.