What Is a Health Savings Account (HSA)?
A Health Savings Account (HSA) is a tax-advantaged account designed for individuals covered by high-deductible health plans (HDHPs) to save for qualified medical expenses. Contributions can be made by the individual or their employer, up to a specified annual limit.
Funds contributed to an HSA can be invested over time and utilized for various qualified medical expenses such as medical, dental, vision care, and prescription drugs.
Key Takeaways
- A Health Savings Account (HSA) is a tax-advantaged tool for saving on medical expenses not covered by HDHPs.
- Contributions to an HSA, as well as its earnings and distributions for qualified medical expenses, are tax-free.
- HSAs can be funded jointly by the employee and employer if owned by the employee.
- Unused account balances can be carried forward, as contributions are vested.
How an HSA Works
HSAs are accessible to individuals with HDHPs, requiring eligibility based on IRS standards. To qualify for an HSA, individuals must:
- Have a qualified HDHP
- Have no other health coverage
- Not be enrolled in Medicare
- Not be claimed as a dependent on someone else’s tax return
The maximum contribution limits for an HSA in 2024 stand at $4,150 for individuals and $8,300 for families, with additional catch-up contributions available for those aged 55 and over.
Contributions to an HSA can only be made in cash and are not limited to just the individual or employer – family members and even self-employed individuals who meet eligibility criteria can contribute.
Individuals enrolled in Medicare are ineligible to contribute to an HSA upon enrollment, although tax-free distributions can still be received for qualified medical expenses.
HSA Special Considerations
HDHPs come with higher annual deductibles but lower premiums compared to other health plans, making the financial benefits context-specific.
To open an HSA, individuals require a minimum deductible and an annual out-of-pocket maximum, with additional expenses shared between the individual and the plan after meeting the deductible.
Example of HDHP
For illustrative purposes, insurers typically cover a percentage of qualified expenses, leaving the remainder to be paid by the individual according to the plan’s terms.
In practice, if a medical claim exceeds the deductible amount, the individual covers a portion of the remaining expenses, with the insurance company contributing towards the rest.
Once the annual deductible is settled, the plan generally covers additional expenses, excluding any costs not included in the plan coverage, which can be paid using accumulated HSA funds.
It’s essential not to mix up health savings accounts with health spending accounts used by Canadian employers to provide benefits for their employees.
Advantages and Disadvantages of an HSA
HSAs present unique benefits and drawbacks depending on individual circumstances.
Pros
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Contribution tax advantages
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Distribution tax advantages
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Investment options
Cons
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Deductible requirements
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Requires extra cash
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Filing requirements
Pros Explained
Contribution tax advantages: Contributions to an HSA are tax-exempt, including employer and individual contributions, with earnings in the account being tax-free. However, excess contributions incur a 6% tax.
Distribution tax advantages: Distributions from an HSA are tax-free when utilized for qualified medical expenses, as per IRS guidelines.
Investment options: HSAs offer opportunities to invest in various securities for potential long-term returns.
Cons Explained
Deductible requirements: To benefit from an HSA, individuals must meet HDHP criteria and be able to afford high deductibles for tax advantages.
Requires extra cash: Individuals funding their HSAs should ensure they can cover the deductible amounts comfortably, as insufficient funds could cause financial strain.
Filing requirements: HSAs involve detailed contribution rules, withdrawal regulations, distribution reporting, and record-keeping responsibilities that may be challenging.
Withdrawals Permitted Under an HSA
Withdrawals from an HSA are tax-free when used for IRS-recognized qualified medical expenses, including deductibles, prescriptions, and other relevant costs.
- Qualified medical expenses cover various healthcare costs, excluding insurance premiums except for specific instances like Medicare or COBRA coverage.
- Non-qualified withdrawals are subject to income tax and a 20% penalty, waived for individuals over 65.
HSA Contribution Rules
Contributions to an HSA are not time-bound and can be carried over to subsequent years if unused, offering flexibility to account holders even when changing jobs.
Moreover, in the event of the account holder’s demise, an HSA plan can be transferred tax-free to a surviving spouse or result in tax implications for non-spousal beneficiaries.
HSA vs. Flexible Spending Account
HSAs and FSAs both cater to medical expenses but differ in aspects like being employer-specific, rollover policies, and contribution flexibility.
- FSAs are employer-provided, while HSAs are individual-owned.
- FSA funds not used within a tax year are forfeited, unlike HSAs.
- Contribution amounts for FSAs are fixed compared to HSAs.
The maximum yearly contribution for FSAs differs from HSAs, with specific limits on rollover amounts.
Can I Open a Health Savings Account (HSA) If I’m Self-Employed?
You can open an HSA if self-employed, provided you have an eligible high-deductible health plan. Explore HSA offerings by reputable institutions like Fidelity, HealthEquity, or Lively to find the right fit for your situation.
Do I Have to Use All of the Money in My HSA Every Year?
Unlike FSAs, HSAs allow unused funds to roll over annually, offering the potential for long-term savings growth or post-retirement investment.
Can I Pay My Insurance Premiums with My HSA Funds?
In most cases, insurance premiums cannot be covered using HSA funds, except for specific scenarios like Medicare premiums or COBRA coverage during unemployment.
The Bottom Line
HSAs are valuable tax-advantaged tools, known as triple tax-advantaged accounts due to their beneficial tax treatment. Starting an HSA early and allowing it to grow can provide financial security, especially as medical expenses tend to rise with age.