How Health Savings Accounts Work
Financial experts tout the benefits of a Health Savings Account, or HSA, but many people are not familiar with how they work. HSAs offer unique benefits that you won’t find with standard health insurance policies or other savings accounts. An HSA helps to minimize healthcare spending, minimize taxes and potentially grow savings through investments. This article will provide an overview of HSAs, including how they work and why you might want one.
What is an HSA?
An HSA is a type of savings account that enables individuals or families to set aside funds to pay qualified medical expenses on a pretax basis. An HSA is used in conjunction with a High Deductible Health Plan where the individual or family must pay a certain amount of healthcare expenses on their own before insurance begins paying. An HSA enables an individual to pay for those health care expenses and future expenses with pretax dollars.
HSAs and High Deductible Health Plans were originally created to help curb health care costs. The premise is that individuals will be more conscious of health care spending if they use their own money.
On the surface, an HSA is a savings account, but the funds can only be used for qualified medical expenses. You contribute funds into the account and then use a debit card or check to pay for your qualified medical expenses with those funds. You can also transfer money into your regular checking account to reimburse yourself for qualified medical expenses.
Who is eligible for an HSA?
To be eligible for an HSA, you must meet the following criteria:
- You must be covered under a High Deductible Health Plan (“HDHP”) for at least the first day of the last month of the tax year.
- You must not have other health coverage except what is permitted by the IRS under “other health coverage”.
- You must be under the age of 65.
- You cannot be claimed as a dependent on someone else’s tax return.
What is a High Deductible Health Plan?
A deductible is the amount of qualified health care expenses you must pay before your health insurance begins paying. A High Deductible Health Plan is a health insurance plan with a higher deductible than a traditional health insurance plan. While participants are required to pay a greater share of healthcare expenses initially, these plans often have lower policy premiums.
Deductibles can vary from plan to plan, but the IRS defines a High Deductible Health Plan as any healthcare plan with a deductible of at least $1,400 for individuals and $2,800 for families. Plans with higher deductibles typically have lower policy premiums.
Insurance will begin paying once a deductible is met, but not necessarily 100% of all future expenses. The insurance company may pay only a percentage of future costs up to an “out-of-pocket” limit. The out-of-pocket limit is the maximum you’re required to pay for deductibles, copayments, and coinsurance. Note that policy premiums are not included in the out-of-pocket limit.
The out-of-pocket limits for high deductible health plans paired with health savings accounts are $7,000 for individuals and $14,000 for families. In 2022, these will increase to $7,050 for individuals and $14,100 for families. Once the out-of-pocket limit is reached, insurance pays for 100% of qualified expenses.
Even though High Deductible Health Plans contain high deductibles and high out-of-pocket limits, the plans offer negotiated rates with most medical providers. For example, if your original bill is $2,000 for a procedure, your HDHP may negotiate the rate down to $1,200, even if you haven’t met your deductible. In this example, you would only be responsible for the negotiated price.
HDHPs and HSAs
So, where do HSAs come in? As you may imagine, it’s difficult to pay for your healthcare out-of-pocket. An HSA helps relieve some of the financial strain by enabling you to pay for your out-of-pocket costs pretax. You contribute to an HSA account with money that isn’t taxed, then pay for your portion of medical expenses with those funds.
What are the benefits of an HSA?
There are many benefits for people who use an HSA.
First, your HSA contributions are tax-deductible on your federal tax return if you make the contributions directly. If your employer makes the contributions via automatic payroll deductions, they are made pretax and deducted from your payroll check.
You can invest your HSA funds in a variety of securities, from mutual funds to stocks and exchange-traded funds. These investments grow tax-free, and all withdrawals for qualified medical expenses are tax-free.
The funds in your HSA rollover. If you don’t use all the funds in one year, you can use them later or let the funds in your HSA grow as an investment. You can also keep using your HSA if you change jobs or insurance carriers. It’s your account as long as you meet the qualifications.
How much can you contribute to an HSA?
For 2021, an individual may contribute up to $3,600 for an individual or $7,200 for a family. For 2022, an individual may contribute up to $3,650 for an individual or $7,300 for a family. Those who are 55 or older can make catch-up contributions of $1,000 per year in addition to their regular contributions. Your employer can contribute to your HSA, but the total contributions must still be within the above limits.
How do you start an HSA?
Starting an HSA is pretty simple. You go through the same basic steps as setting up any other insurance plan and investment account. First, enroll in an HDHP. You can contact your employer to see if they offer one or enroll in one yourself. If you’re self-employed, check with your health insurance provider, insurance broker, or agent. Once you enroll in an HDHP, ask your employer if they offer an HSA option. If so, they can set up your account and deposit money into the account on your behalf via automatic payroll deductions. If your employer doesn’t offer an HSA, look for a bank or financial institution that provides these types of accounts. Most larger financial institutions have an HSA option.
What if you need to make a non-qualified withdrawal?
If you withdraw funds from your HSA for something other than a qualified medical expense, it’s considered a non-qualified withdrawal. There are penalties and taxes for this type of withdrawal, depending on your age. If an individual withdraws funds from an HSA for non-qualified expenses and is under the age of 65, then the withdrawn amount will be subject to income taxes and a 20% penalty. However, if an individual is over the age of 65, then the withdrawn amount will only be subject to income taxes. There are no penalties.
Is an HSA right for you?
An HSA can be an excellent investment for certain people. If you are generally healthy and have minimal medical expenses, an HDHP and HSA can help you save money on healthcare and increase your investment options. However, if you have several health conditions and regularly need expensive care, you may have trouble funding your HSA and paying your deductibles. In this case, an HDHP and HSA may be more expensive than your current insurance plan. Whatever your situation, we suggest performing the calculations to project your healthcare requirements and cash outlays for each plan available to you.
The purpose of this article is to provide an overview of health savings accounts and is not meant to replace discussing your unique situation with an expert. Please contact our office if you would like to discuss if a health savings account is right for you. We’re always happy to help.