When signing up for health insurance through your job, you may have been given the option of opening an HSA, or health savings account.
An HSA isn’t like a regular savings account. For one thing, there are a bunch of rules around how you can contribute and spend the money. But it can be a very useful and convenient way to set aside money for medical expenses while potentially saving you hundreds or even thousands of dollars in the long run.
Here, we’ll explain how HSAs work and how they can benefit you.
What Is an HSA?
The first thing you should know about an HSA is that you need to have an HDHP in order to qualify for one.
An HDHP stands for a high deductible health plan. With high-deductible plans, you generally pay less in premiums but have to meet a high annual deductible before your plan pays.
A deductible is the money you pay out-of-pocket before your insurance kicks in and starts providing certain benefits. Your premium is the monthly fee you pay to get health coverage.
You can’t open a health savings account with just any health plan with a high deductible. According to the IRS, the deductible has to be no less than $1,350 for an individual or $2,700 for a family to qualify as a high deductible health plan in 2019. Those deductibles can go as high as $13,500 for a family.
In addition, you can’t be enrolled in Medicare, have other health coverage or be claimed as a dependent on someone else’s tax return in order to be eligible to open an HSA.
But if you do meet all those criteria, you’re in.
So what’s the big deal about having an HSA anyway?
The Benefits of an HSA
A health savings account allows you to save money for various medical expenses without being taxed on that money. Any savings you don’t spend in a current year rolls over to the following year, and the money in your HSA stays with you even if you switch insurance plans, change jobs or retire.
If you have this benefit through your job, your employer can direct a portion of your paycheck to your health savings account before taxes are taken out. If you make contributions to your HSA with income that’s already been taxed, you can deduct that money when filing your income taxes.
“The advantage of contributing through payroll is you save not just federal and state income taxes but you also save on FICA taxes,” said Paul Fronstin, director of the health research and education program at the Employee Benefit Research Institute.
Acronym alert: FICA stands for the Federal Insurance Contribution Act. Your FICA taxes are what you pay to fund Medicaid and Social Security.
You also aren’t taxed when you spend HSA dollars, provided you’re spending the money on qualified medical expenses.
The IRS has an entire list of qualified expenses, which includes things like:
- Dental care
- Eye glasses
- Chiropractic care
- Breastfeeding supplies
You’ll usually receive a debit card or checks to spend your HSA money, but in some cases, you’ll have to pay out of pocket and get reimbursed later.
When you spend money from your HSA, make sure to save receipts, your explanation of benefits forms or other types of documentation.
“You don’t have to send any documentation to your HSA provider,” Fronstin said. “The IRS requires that you have documentation, and if you get audited, you’re going to need that documentation.”
Another benefit of having a health savings account is that you don’t have to pay taxes for any earnings from your account.
“If you open an HSA, the money goes into a bank, and it earns interest like a bank account,” Fronstin said. “The interest rates are not high, but once you have a certain amount of money in your account… your HSA provider will likely permit you to invest that money in mutual funds.”
Besides all those tax benefits, another upside of an HSA is that your employer — and other individuals — are allowed to contribute to your account. Can you say free money?
The IRS does cap how much can be contributed to an HSA in a given year, though. In 2019, you can contribute up to $3,500 for individuals or $7,000 for families. If you’re 55 or older, you can contribute an additional $1,000.
The Challenges With HSAs
One thing to keep in mind when you have an HSA is that you may be charged a fee to maintain your account. Also, if you use the money for something that’s not a qualified expense and you’re younger than 65, you’ll be taxed on it plus you’ll be hit with a 20% penalty.
After you reach age 65, you can use your HSA savings for nonmedical expenses without incurring a penalty, but you’ll still be taxed for it.
Other challenges exist — not with having a health savings plan directly, but with having a high deductible health plan. Deciding which health insurance is right for you and your family is a personal decision, Fronstin said, and opting into a high deductible health plan won’t be the right choice for everyone.
Some people aren’t able to pay for health costs out of pocket before meeting their deductible and having insurance benefits kick in — resulting in people forgoing medical care to save money.
High deductible health plans have also been criticized as being more for young, healthy people who don’t need much medical care. Standard preventive care, like getting your annual checkup, is generally covered under a high deductible health plan without having to reach your deductible. But patients who have ongoing medical needs could end up spending a lot of money before getting any benefit from their insurance.
However, recent changes made by the federal government expanded the list of what’s considered preventive care and now includes 14 treatments, medications or devices for people with ongoing conditions like diabetes and heart disease.
“These plans became a little more friendlier for people with chronic conditions,” Fronstin said.
Nicole Dow is a senior writer at The Penny Hoarder.