Quickstart Guide to the HSA

As healthcare costs continue to rise, employer-provided healthcare benefits are becoming a critical part of the employee’s arsenal. One such benefit gaining popularity is the Health Savings Account (HSA), a versatile and effective tool for saving for healthcare expenses. Let’s take a look at the plan’s requirements, advantages, and disadvantages.

What is an HSA?

An HSA is like a cross between a 401(k) and a savings account but with some distinct differences. For instance, like a savings account, the HSA is held in a bank or other financial institution, and you receive a debit card or checks. Also, similar to a 401(k) the HSA has special tax treatment. Yet, unlike a 401(k) or savings account, HSAs are intended for qualified medical expenses only.

Unlike a 401(k) or savings account, HSAs are intended for qualified medical expenses only.

Are you eligible?

HSAs require High-Deductible Health Plan (HDHP) coverage. HDHPs typically have lower monthly premiums than other plan types but have higher deductibles (hence the name).

HSAs require High-Deductible Health Plan (HDHP) coverage.

No Contributions Allowed After Age 65

Another HSA requirement is that contributions end at age 65. Once you’re over age 65, you cannot make contributions, but you can continue to use the funds already in the account for qualified medical expenses.

No Other Health Coverage

You are not eligible if you have any other healthcare coverage, including coverage under a spouse’s healthcare plan.

What are the advantages of an HSA?

From its tax deferral, spending flexibility, to its self-directed options and employer match, the HSA provides many advantages that make it a powerful saving tool.

You can make pre-tax contributions.

Tax Benefits

The HSA’s tax-advantaged status allows you to make pre-tax contributions through payroll deductions. This means that your contributions are excluded from your gross income and therefore are not subject to federal or (most) state income taxes.

The tax-deferral will allow you reduce your taxable income up to the maximum contribution limit, which for 2020 was $3,550 for individuals and $7,100 for families, plus an additional $1,000 “catch-up” for anyone age 55 or older.

To top it all off, HSA investment earnings grow tax-free until distribution. And if the funds are withdrawn for qualified medical expenses, such as deductibles, co-payments, and prescription drugs, then no tax is due.

Withdrawals are tax-free if used for qualified medical expenses.

No Spending Requirement

Unlike the Flexible Spending Account (FSA), there is no requirement to deplete your account within the year, meaning your HSA balance can compound year after year. This ability to accumulate on a tax-deferred basis is a powerful benefit, especially as you approach retirement when you are likely to incur most of your healthcare costs.

You Own the Account

Your HSA comes with you.

The HSA is completely yours. So if you leave your job or change health plans, your HSA and all the money in it comes with you.

Retirement Supplement

Because you can withdraw your HSA funds for any purpose penalty-free after age 65, you can potentially fund a portion of your retirement with the tax-deferred contributions that grew over the years.

Allowed to Invest the Funds

Another advantage is that many HSAs allow you to invest in stocks, ETFs, and mutual funds. This flexibility enables you to tailor your account based on your risk preferences and desired rate of return.

Matching Contributions

Some employers match!

Last but certainly not least is the employer match. Like many 401(k)s, more employers are offering HSA matching contributions. Who doesn’t like free money?

What are the disadvantages of an HSA?

Although Health Savings Accounts (HSA) have many advantages, they do have some disadvantages, including the High-Deductible Health Plan (HDHP) requirement, penalties for nonqualified expenses, and recordkeeping.

HDHP Requirement

The fact that you must have a High-Deductible Health Plan (HDHP) to be eligible for an HSA, can be a no-go for many. HDHPs are not always the best option, especially if you expect significant healthcare expenses. Although, HDHPs have lower monthly premiums, if you have an expensive medical event, you will have to pay a higher deductible. In which case, you may be better off with an insurance plan that charges higher monthly premiums but covers a greater percentage of your costs. Generally, HDHPs are best if you expect minimal healthcare costs and want to keep your monthly insurance premiums low.  

HDHPs are not always the best option, especially if you expect significant healthcare expenses.

Penalty for Nonqualified Expenses

Another drawback to the HSA is the limitation on the use of its funds. As noted, deductibles, co-payments, and prescription drugs are qualified medical expenses; however, insurance premiums typically are not, nor are non-prescribed over the counter drugs. If you withdraw funds for non-qualified expenses before age 65, you could owe taxes and a 20% penalty.

If you withdraw funds for non-qualified expenses before age 65, you could owe taxes and a 20% penalty.

Record Keeping is a Must

Another drawback to be aware of is the record keeping. Since you must be able to provide proof of your qualified medical expenses to the Internal Revenue Service (IRS), keeping all of your receipts is an essential function when you participate in an HSA.

Is an HSA right for you?

The Health Savings Account (HSA) is a flexible and efficient savings tool that can help reduce your out-of-pocket healthcare costs. However, everyone is not eligible for the HSA, nor is the account right for everyone. Therefore, when deciding if the HSA is right for you and your family, you should explore your options and take stock of your medical expenses. Some questions that may help your decision are: Do you have a High Deductible Health Plan? If not, should you get one? Do you expect to have substantial healthcare expenses? Do you prefer low monthly premiums in exchange for a larger deductible?

Published by Jose Armenta, MsBA, ChFC®, EA

Jose is a fee-only financial planner serving veterans who are Federal employees.

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