By Kristina Russo | American Express Credit Intel Freelance Contributor
6 Min Read | November 30, 2020 in Money
Health Savings Accounts (HSAs) are an increasingly popular tool to help manage medical costs – effectively lowering costs because you pay for them with pre-tax dollars.
It’s important to understand their strict eligibility requirements and withdrawal restrictions before opening one up.
Between tax advantages and investment options, they can be a useful way to build long-term savings, too.
Health Savings Accounts (HSAs) are savings accounts that let you put aside money to pay for qualified medical expenses. Introduced in 2005, these triple-tax-advantaged savings accounts have been growing more common: In 2019, there were over 26 million HSAs, an increase of 12% from the year before.1 While strict rules determine who can open an HSA, how much you can contribute, and what you can use the funds for, HSAs can also be used as long-term savings accounts.
I’ll take you through the details of what HSAs are, how they work, and what you can do with them.
An HSA is a savings account that lets you pay for qualified medical expenses using pre-tax dollars. Paying for medical expenses with untaxed dollars can help you save money in the long run, but you can only be eligible for an HSA if you meet specific stipulations like having a high-deductible health plan. They’re considered triple-tax-advantaged because you pay no taxes on:
HSAs are set up with a “trustee,” usually a bank or insurance company, and are usually coordinated with your employer or health plan provider. But you can set up an HSA on your own, too, as long as you have a high-deductible health plan. You, your employer, and any other person – like a family member – can contribute to the account. Contributions are invested by the trustee and any investment income earned is added to your account balance. You can then withdraw funds to pay for qualified medical expenses, tax-free.
The maximum amount you can contribute each year is limited by the IRS and adjusted periodically. Experts often recommend maxing out HSA contributions if you can. In 2020, you can contribute up to $3,550, or $7,100 for families.2 If you are 65 years of age or older, you can also make catch-up contributions of $1,000.3
Most HSAs will provide you with a debit card and/or checkbook to pay for qualified medical expenses. But sometimes you may need to pay out-of-pocket and submit a claim for reimbursement. Either way, it’s important to keep receipts and expense documentation.
There are a few specific requirements to be eligible for an HSA:4
In addition, HSA eligibility uses the IRS’ “last-month rule.” This means that you are considered an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year, which is December 1 for most taxpayers.
As defined by the IRS, common qualified medical expenses include:5
The recently passed CARES Act expanded the list of qualifying expenses even further, to include things like telemedicine and over-the-counter drugs, among others. When in doubt, contact your HSA provider to ensure you don’t trigger penalties for unauthorized purchases.
HSAs have a few key benefits that make them unique savings vehicles:
Since many HSA benefits are related to taxes, you may want to check with your personal tax advisor to best understand if they’re right for you.
Most experts agree that the advantages of HSAs outweigh the disadvantages for most people. The most noted disadvantages include:
Similar to other tax-advantaged accounts, like IRAs and 401(k)s, HSAs also can be a stand-in for regular personal savings accounts. Typically, funds are only withdrawn tax-free for medical expenses, but you can access your balance for other purposes by paying a 20% penalty to the IRS if you are younger than age 65.7
After age 65, you can access your HSA funds without penalty for anything, not just medical expenses. You will, of course, pay income tax on the withdrawals – since you didn’t pay tax when you originally earned the money – similar to IRA and 401(k) withdrawals. Chances are, you’ll also be in a lower tax bracket at that time.
|Pros of HSAs||Cons of HSAs|
1 2019 Midyear Devenir HSA Research Report, Devenir Research
2 “Healthcare Savings Account (HSA),” HealthCare.gov
6 2019 Midyear Devenir HSA Research Report, Devenir Research