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Main Findings
Health Savings Accounts (HSAs) offer a way for individuals with high-deductible health plans (HDHPs) to pay for medical expenses and save for future health costs on a tax-free basis. The benefits of HSAs include tax savings, flexibility, savings opportunities, control, portability, and affordability.
A Health Savings Account (HSA) is a type of savings account that allows you to set aside money on a pre-tax basis to pay for qualified medical expenses.
By using untaxed dollars in an HSA to pay for deductibles, copayments, coinsurance, and some other expenses, you can lower your overall health care costs. HSA funds generally may not be used to pay premiums.
An HSA can be used only if you have a High Deductible Health Plan (HDHP) — generally any health plan (including a Marketplace plan) with a deductible of at least $1,400 for an individual or $2,800 for a family. When you view plans in the Marketplace, you can see if they’re “HSA-eligible.”
An HSA is “owned” by the individual, which differentiates it from company-owned Health Reimbursement Arrangements (HRAs) that are an alternate tax-deductible source of funds paired with either HDHPs or standard health plans. HSA funds may currently be used to pay for qualified medical expenses at any time without federal tax liability or penalty.
Why Use a Health Savings Account (HSA)?
There are several reasons why you might want to consider using an HSA:
Tax Savings
Contributions to your HSA are fully deductible, just like an IRA. Withdrawals to pay qualified medical expenses, including dental and vision, are never taxed.
Interest earnings accumulate tax-deferred, and if used to pay qualified medical expenses, are tax-free. HSA accounts can be an excellent way to save for future health expenses, while getting a tax write-off in the process.
Flexibility
You can contribute at any time during the year, and your HSA balance rolls over from year to year. So unlike a Flexible Spending Account (FSA), you won’t lose your HSA dollars if you don’t spend them by the end of the year.
Savings Opportunity
An HSA is a powerful savings tool. The money you save on taxes can be put into the account and earn interest. Over time, your contributions and earnings can add up to a significant sum, which can be used to pay for health care in retirement.
Control
You make all the decisions about how much money to put in the account, which expenses to pay from the account, which company will hold the account, and which investments to make.
Portability
Accounts are completely portable, meaning you can keep your HSA even if you change jobs, change your medical coverage, become unemployed, move to another state, or change your marital status.
Affordability
You should be able to lower your health insurance premiums by switching to health insurance coverage with a higher deductible.
Remember, it’s important to consult with a qualified tax advisor or legal professional before making any decisions about your personal finances.
The formula for Health Savings Account (HSA) Contributions
The formula for calculating your HSA contribution limit is quite straightforward. It’s based on the type of high-deductible health plan (HDHP) coverage you have, your age, and the date you become an eligible individual.
For self-only HDHP coverage, you can contribute up to $3,650. For family HDHP coverage, you can contribute up to $7,300. These limits are for the year 2024 and they are indexed annually for inflation.
If you’re age 55 or older at the end of your tax year, your contribution limit is increased by $1,000. This is often referred to as a “catch-up” contribution.
However, if you weren’t an eligible individual for the entire year or changed your coverage during the year, you might need to prorate your contribution limit.
How to Calculate Your HSA Contribution Limit
Calculating your HSA contribution limit can be done in a few steps:
Determine Your HDHP Coverage Type
First, you need to determine whether you have self-only or family HDHP coverage. This will determine your base contribution limit.
Consider Your Age
If you’re 55 or older by the end of the tax year, you can make an additional catch-up contribution of $1,000.
Prorate if Necessary
If you weren’t an eligible individual for the entire year or if you changed your coverage during the year, you’ll need to prorate your contribution limit.
To do this, you calculate the contribution limit for each month based on your eligibility and coverage for that month. You then total these amounts and divide by 12 to find your annual contribution limit.
Here’s an example:
Let’s say you have self-only HDHP coverage from January to July, and then switch to family HDHP coverage from August to December.
Your contribution limit for January to July would be 7/12 of $3,650, and for August to December, it would be 5/12 of $7,300. You would then add these two amounts together to get your annual contribution limit.
Examples of Using a Health Savings Account (HSA)
Let’s look at further examples to illustrate how an HSA works:
Example 1:
John, a single, healthy 30-year-old with a high-deductible health plan (HDHP), decides to fully fund his HSA at the beginning of the year. He contributes $3,650. Throughout the year, he incurs $1,000 in qualified medical expenses.
He decides to pay these expenses out-of-pocket and leaves his HSA funds untouched. By the end of the year, his HSA has grown to $3,750 due to interest. John’s net savings for the year are $2,750 ($3,750 in his HSA minus the $1,000 he paid out-of-pocket).
Example 2:
Sarah and her family are covered under a family HDHP. They contribute the maximum amount of $7,300 to their HSA. Unfortunately, they have a year of high medical costs and spend $5,000 out of their HSA. At the end of the year, they have $2,500 left in their HSA. Despite their high medical costs, they still have funds set aside for future medical expenses.
Example 3:
Mike is 60 and planning for retirement. He’s in good health and has been maximizing his HSA contributions for several years. His HSA has grown to $50,000. He decides to use $5,000 from his HSA to pay for a qualified medical expense. Because he used the funds for a qualified expense, the withdrawal is tax-free.
These examples illustrate the flexibility and potential tax advantages of HSAs. However, everyone’s situation is different, and what works for one person might not work for another.
Limitations of Health Savings Accounts (HSAs)
While HSAs offer many benefits, they also have some limitations:
- High-Deductible Requirement: To be eligible to contribute to an HSA, you must be enrolled in a high-deductible health plan (HDHP). This means you’ll have to pay more out-of-pocket before your insurance starts to cover your medical costs.
- No Prescription Coverage: HSAs typically don’t cover prescription drugs unless you’ve met your deductible. This can be a significant out-of-pocket expense.
- Potential for Misuse: If you use your HSA funds for non-qualified expenses and you’re under age 65, you’ll have to pay income tax on the withdrawal, plus a 20% penalty.
- Recordkeeping: You must keep receipts to prove that your withdrawals were used for qualified health expenses. This can be cumbersome and time-consuming.
Conclusion
Health Savings Accounts (HSAs) offer a way for individuals with high-deductible health plans (HDHPs) to pay for medical expenses and save for future health costs on a tax-free basis.
The benefits of HSAs include tax savings, flexibility, savings opportunities, control, portability, and affordability. However, they also come with limitations such as high-deductible requirements, no prescription coverage, potential for misuse, and the need for recordkeeping.
Despite these limitations, HSAs can be a valuable tool for managing healthcare costs, especially for those who are relatively healthy, those who want to save for future healthcare expenses, and those who want to take advantage of the tax benefits.
As always, it’s important to consult with a qualified tax advisor or legal professional before making any decisions about your personal finances.
References
- Internal Revenue Service. (2023). Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans. Retrieved from https://www.irs.gov/publications/p969
- U.S. Department of the Treasury. (2023). Health Savings Accounts (HSAs). Retrieved from https://www.treasury.gov/resource-center/faqs/Taxes/Pages/Health-Savings-Accounts.aspx
- Mayo Clinic. (2023). High-deductible health plan (HDHP). Retrieved from https://www.mayoclinic.org/healthy-lifestyle/consumer-health/in-depth/health-savings-accounts/art-20044058
- Healthcare.gov. (2023). High Deductible Health Plan. Retrieved from https://www.healthcare.gov/glossary/high-deductible-health-plan/
FAQ
Yes, you can use your HSA to pay for the qualified medical expenses of anyone you claim on your tax return, even if your family member is not covered by your High Deductible Health Plan (HDHP).
Once you turn 65, you can still use your HSA to pay for out-of-pocket medical expenses tax-free. However, you can also use your HSA for non-medical expenses. In this case, the amount withdrawn will be taxable as income but will not be subject to any other penalties.
No, you can’t make new contributions to an HSA once you’re enrolled in Medicare. However, you can still use existing funds in your HSA to pay for qualified medical expenses.
Yes, many HSA providers offer investment options. The earnings on these investments are also tax-free, as long as they’re used for qualified medical expenses.
HSAs are portable, so if you change jobs, your HSA goes with you. Your account stays with you, regardless of changes in your employment or health insurance coverage.
If the account holder’s spouse is the designated beneficiary, the HSA becomes their HSA. If the beneficiary is not the account holder’s spouse, the account stops being an HSA, and the fair market value of the HSA becomes taxable to the beneficiary.
