What is a Health Savings Account and Should You Have One?

If you are looking for health insurance coverage and options, you have likely come across something called a Health Savings Account, or HSA. But, what exactly is an HSA, and should you have one? Having information about the advantages and disadvantages of health savings accounts should help you determine whether they meet your needs better than other savings options.

What is a Health Savings Account?

A Health Savings Account is a type of savings account that can only be used for qualified medical expenses. Because the money in HSAs is untaxed, people can save on deductibles, copayments, coinsurance, and other qualified medical expenses. 

HSA funds typically can't be used to pay premiums. To be eligible for a health savings account, you must be enrolled in a High Deductible Health Plan (HDHP). 

Benefits of Health Savings Accounts

The benefits of HSAs include:

High number of Qualifying Expenses

A lot of medical expenses qualify to be paid for by a health savings account, including a wide range of health, mental health, and dental services.

Others Can Contribute to Your HSA

Other people can contribute to your HSA, including your employer, relatives, or anybody who wants to. However, there are limits on contributions. For example, the IRS set the limit at $3,600 for individuals and $7,200 for families in 2021. There's an additional $1,000 "catch-up" contribution limit for anyone over the age of 55 by the end of the tax year.

Tax-Free Contributions

Since contributions are generally made with pre-tax dollars via payroll deductions, they don't get included in your gross income and therefore aren't subject to federal income tax. In most states, contributions aren't subject to state income taxes either.

After-Tax Contributions are Tax Deductible

If you make contributions to your HSA with after-tax dollars (your net income after deducting all federal, state, and withholding taxes), they can be deducted from your gross income.

Withdrawals are Tax-Free

HSA withdrawals aren't subject to federal, and in most cases, state taxes, as long as you use the funds for qualified medical expenses.

However, your health savings account can be used as an investment account, permitting you to buy stocks and other securities to possibly boost your returns. It's important to note that just because it is allowed does not mean it is recommended. Investing the money carries a large risk of loss. Speak with a financial professional before you begin using your health savings account for investing. You don't want to make a decision that leads to financial loss.

Tax-Free Earnings

All interest and other earnings on the funds in your HSA are not taxed. Most health savings accounts earn a marginal amount of interest, less than 0.1%. 

Annual Rollover

If there's leftover money in your health savings account at the end of the year, it will roll over to the next year— offering more flexibility than Flexible Spending Accounts or FSAs. FSAs can only be carried over up to $500 or two and a half months into the next plan year.

Transferability

Your HSA funds remain available for future qualified medical expenses even if you make major changes like change health insurance plans, employers, or retire. Your health savings account is essentially a bank account that lets you decide how and when to use the money.

Convenience

The majority of HSAs will issue you a debit card, allowing you to use it to pay for prescriptions, co-pays, and other eligible expenses immediately. 

If you choose to wait for your medical bills to come in the mail, simply call the billing number listed on the bill and make a payment over the phone with your health savings account debit card information.

Alternatively, you can reimburse yourself for medical bills that you pay for with a different form of payment using your health savings account.

Disadvantages of Health Savings Accounts

Some of the major disadvantages associated with HSAs include:

High Deductible Requirement

As we mentioned, in order to be eligible for an HSA, users must be enrolled in high deductible health plans. These plans can put a more significant financial burden on you than other health insurance plan types. Though you'll pay less in premiums every month, it can be challenging— even with money in an HSA— to come up with enough cash to meet the deductible for an expensive medical procedure. This is something especially important to take into consideration for people anticipating heft medical bills in a specific plan year.

As you may have guessed from the name, the deductibles on a high deductible health plan are significantly higher than the minimums required and can often be as high as the maximum out-of-pocket costs allowed.

Increased Pressure to Save

HSAs can make you feel reluctant to seek health care when you need it because you don't want to spend the money you have been saving. This becomes especially dangerous for people with chronic health conditions.

Taxes and Penalties

If you were to withdraw money from your health savings account for non-qualified expenses before you turn 65, you would owe income taxes on the funds plus a 20 percent penalty. After you turn 65, you would owe taxes, but there would be no penalty. 

Keeping Up with Receipts

You are required to keep the receipts from your HSA withdrawals in order to prove you used the funds for qualified health expenses. These records are necessary if you ever get audited by the IRS, so it's imperative that you keep up with them and store them in a safe, non-destructible, easily accessible place.

Fees

Some health savings accounts charge a monthly maintenance fee or a per-transaction fee. These fees are generally not very high, although they are higher than any interest the account earns. They also cut into your bottom line. These fees may be waived if a specific minimum balance is maintained—it changes with each institution.

Why Were HSAs created?

Health savings accounts (as well as high deductible health plans) were created to help control health care costs. The goal is to get people to spend their health care dollars more wisely since they are using their own money.

How Can I Set Up a Health Savings Account?

To get started setting up your HSA, you should contact your HR department at work to see if they have an existing arrangement or can suggest a financial intuition that provides health savings accounts.

Your insurer should also be able to recommend or offer HSAs. Most major financial institutions offer health savings accounts, so checking with your bank and going through them is another option. Just make sure you understand any fees you may incur for maintenance.

Don't forget that you first need to enroll in a qualified high-deductible health plan before you are eligible for an HSA. Once you've done that, you can choose where you want to set-up your health savings account and complete the application process, and then set up funding for your HSA.

What Can I Use My HSA to Pay For?

As mentioned, you can pay for a wide range of qualified medical expenses with your health savings account. Qualified expenses include:

• Prescription drugs

• Health insurance plan deductibles, copayments, coinsurance

• Flu shots

• Dental services indulging braces, crowns, and bridges

• Vision care including Lasik eye surgery, contacts, and glasses

• Psychiatric care

• Long term care services

• Medially related transpiration and lodgings 

• Certain health premiums, including but not limited to COBRA

• Physical therapy 

Has the COVID-19 Stimulus Package Affected Health Savings Accounts?

You likely know about the recent stimulus package, The American Relief Plan (TARP), signed into law by President Joe Biden. What impact will it have on HSAs? 

Qualifying Medical Expenses are Expanded

A health savings account has always been a convenient way to get tax-free prescription medications. In an effort to ease the strain from COVID-19, Congress now includes over-the-counter medications on the list of eligible expenses. As people continue to stock up on acetaminophen, ibuprofen, sinus medications, and menstrual care products, they don't have to pay tax as long as they use their HSA to pay. The new rule has no expiration date.

Telemedicine Will be Covered Through 2021

Before ARP was signed into law, HSAs could not be used to pay for video or phone consultations with health care providers until the deductible was met. The new law relaxes that and allows all health savings account participants to reach out to doctors via telehealth and have their visits paid for with their tax-free HSA funds. This change is only temporary and will expire on December 31, 2021.

Allowing Laid-Off Workers to Maintain Health Coverage

Workers that have been laid off or experienced a reception in hours in the wake of the global pandemic are at risk of losing health care. The good news is that people collecting unemployment benefits who have health savings accounts can use pre-tax dollars in the account to pay for premiums for a new independent health care policy or secure COBRA coverage.

How Does an HSA Work?

There are a few basic steps to how health savings accounts function, including:

• Funding: 

  You and likely your employer will contribute to your health savings account on a pre-determined schedule.

• Accessing the Money: 

  As soon as an eligible health care expense pops up, you can pay for it with your HSA debit card, or you can pay the bill out-of-pocket and request reimbursement. Remember to always keep your receipts!

• Requesting Reimbursement:

   When you don't use your HSA debit card, submitting a reimbursement request is very quick and easy. You can also easily upload the receipts online or with a mobile app.

• Reimbursement Processing: 

  Once received, your financial institution will process the request and reimburse you via check or direct deposit.

• Account Management: 

  Log on to your health savings account online to check your balance, request reimbursements, and access other valuable tools.

Can I Transfer Funds from my IRA Account to my Health Savings Account?

Yes, the IRS allows a one-time transfer of IRA funds to an HSA. However, the amount of the IRA rollover can't exceed your yearly HSA contribution limit.

IRS regulations also require you to maintain eligibility for Health Savings Account contributions for a 13 consecutive month period, starting the month of the IRA transfer. If you become ineligible for HSA contributions for reasons other than disability or death, you must pay the income tax and an additional 10 percent tax on the transferred amount.

What Happens to My HSA Funds if I Lose HDHP Coverage?

Once you deposit money into your HSA, the account may be used to pay for tax-free qualified medical expenses, even if you lose your HDHP coverage. The money in your account will automatically roll over every year and will keep doing so until you use it.

There is no set time limit in which you have to use the money. Once you discontinue HDHP coverage and/or seek coverage from another health plan that disqualifies you from a health savings account, you can no longer make HSA contributions. But, because you own the account, you can continue to use it for future expenses.

What Happens to my HSA Funds When I Turn 65?

When you turn 65, you can keep using your account tax-free for out-of-pocket health expenses. When you enroll in Medicare, you can start using your HSA to pay for your Medicare premiums, deductibles, co-pays, and coinsurance under any Medicare part.

If you have retiree health benefits via a former employer, you are still eligible to use your Health Savings Account to pay for your share of retiree medical insurance premiums.

You cannot, however, use your HSA to buy a Medicare supplemental insurance policy, also known as a "Medigap" policy.

Once you turn 65, you can also begin using your HSA to make purchases on things besides health care expenses. If you do use the account for other expenses, the amount you withdraw will be taxable as income, but you won't face any other penalties.

People under 65 who use their health savings accounts for non-medical expenses will have to pay the income tax as well as a 20 percent penalty on the amount of the withdrawal.

Can I Borrow Against My Health Savings Account?

No, you can't borrow against the funds in your health savings account. You can, however, withdraw the money from your HSA whenever you please for any purpose. Of course, if HSA funds are used for purposes that are not approved, you will likely be required to pay income tax and a 20 percent penalty if you're under the age of 65.

Should I have a Health Savings Account?

The answer to this question will vary from person-to-person. As you weigh your options, consider your budget and any health care needs you can anticipate in the next year. 

If you're in good health and you are interested in saving for future health care expenses, a health savings account may be a good choice for you. If you are nearing retirement, a HSA may make sense because you can use the funds to offset the costs of post-retirement medical care.

But, on the other hand, if you anticipate needing expensive medical care in the upcoming year and it would be hard for you to meet a high deductible, a health savings account may not be the best route for you. The good news is you can explore policies and options in one easy place with PolicyScout.