Your Next Healthy Habit: The HSA

One of the top 10 questions I get from clients is should I open an HSA (Health Savings Account)? It is open enrollment season and HSAs have risen in popularity over the last few years, so let me take the opportunity to address the question here.

First, what are HSAs?

HSAs are personal savings accounts that can only be used for qualified health care expenses and out-of-pocket costs not covered by health plans. They offer tax benefits, spending flexibility, and portability.

Second, who is eligible?

To contribute to an HSA, you must be enrolled in a qualifying high-deductible health plan (HDHP). For 2022 the HDHP for individuals must have a deductible of at least $1,400 and an out-of-pocket medical expense limit of $7,050, and the HDHP for families must have a deductible of at least $2,800 and an out-of-pocket medical expense limit of $14,100.

Third, how do I get one?

You can enroll in an HDHP and an HSA through your employer if available, or find an HDHP on the health insurance marketplace and an HSA through a financial institution.

Here is a summary of the advantages and disadvantages of HSAs:

Advantages:

  • If you make contributions with pre-tax dollars, they are excluded from your gross income.
  • If you make contributions with after-tax dollars, you can deduct them from your gross income on your tax return.
  • Contributions can earn interest and be invested.
  • Your investments can grow and compound on a tax-deferred basis, which means there are no capital gains taxes on earnings.
  • Withdrawals are tax-free for qualified health care expenses.
  • You don’t have to make withdrawals in the year that the expenses are incurred (just save the receipts for the year in which you do make the withdrawals).
  • Any unused money at the end of the year rolls over to the next year (unlike Flexible Spending Accounts (FSAs)).
  • The account is always owned by you even if you change employers or terminate employment.
  • When HSA money is used to pay for health care costs in retirement, it has more buying power than money from retirement plans like 401ks where you will owe income taxes on withdrawals.

Disadvantages:

  • It can be challenging to budget how much to save as medical expenses are often unpredictable.
  • HSAs have low contribution limits – the 2022 contribution limit is $3,650/year for individuals with additional catch-up contributions of $1,000 between ages 55 and 65. (This amount is reduced by any employer contributions excluded from gross income.)
  • Once you enroll in Medicare at age 65 you can no longer contribute.
  • If you withdraw funds for nonmedical expenses before age 65, you will have to pay income taxes on the money and an additional 20% penalty. If you withdraw funds for nonmedical expenses after age 65, you don’t have to pay a penalty but you will have to pay income taxes on the money.

For an HSA to be worth it, you should be relatively healthy and good with recordkeeping. If this describes you, consider adding HSAs to your financial to-do list. “I don’t like tax savings” said no one ever.