Health Savings Accounts Explained: Investing in your Health
Typically when we think of Tax Advantaged accounts, we think of 401(k)s and Roth IRAs. These are the most commonly discussed tax advantaged accounts but there are plenty out there. We have talked about 529 College Savings Plans which help you save for education expenses, but there are also accounts to help invest for Health Expenses. In the US, we generally receive Health Insurance from our employer. So what can you do if you’re self employed or retire early? This is where an HSA can come in handy.
What is a Health Savings Account?
A Health Savings Account (HSA) is a tax advantaged account for those with high-deductible Health Plans to help save for qualifying health expenses. You can save or invest these funds into stocks or other securities. You can think of these accounts a lot like a combination Traditional and Roth IRA. By that I mean, the contributions are tax deductible (like a Traditional IRA) and then the earnings grow and can be withdrawn tax free (like a Roth IRA). That means you won’t pay any taxes on distributions as long as they are used for qualified Medical Expenses as determined by the IRS. This includes medical, dental, and vision care. You can find the full list of Qualifying Medical Expenses at this link. These accounts can be owned by individuals or sponsored by an employer.
Who is Eligible for an HSA?
As we’ve mentioned above, you must have a High Deductible Health Plan (HDHP). Since HSAs tend to go hand in hand with an HDHP, if you have a qualifying Health Plan, you will likely be offered an HSA account as well. It is a bit more complicated than that though. The IRS expects you to meet the following criteria;
Have a qualifying High Deductible Health Plan
Have No Other Health Plan
Not be Enrolled in Medicare
Not be listed as a Dependent on Someone else’s Tax Return
As you can see, these requirements don’t have employment specifications, so if you’re self-employed, retired, or anything in between, you’re eligible for an HSA if you meet the previously listed requirements.
How do HSAs work?
HSAs work much like any other tax advantaged account. First, you must meet the eligibility requirements listed above. Once you do, you will be able to enroll in an HSA. As we mentioned in the previous section, if you are already enrolled in an HDHP, you were likely also offered an HSA to enroll in.
Next, you’ll need to make contributions. What is interesting with an HSA is that anyone can contribute to your HSA. So, if you have an employee sponsored HSA, you and your employer may both contribute and there will likely be some form of matching available. However, if you enrolled in an HSA yourself, you or even family members and friends can contribute to your HSA. There are contribution limitations however. In 2022, Individuals can contribute up to $3,650 while Families can contribute up to $7,300 per year. In 2023, that is expected to increase to $3,850 and $7,750 for Individuals and Families respectively. These contributions can be used to invest in stocks or securities in order to gain higher returns.
Finally, when you have a qualifying Medical expense, you can withdraw distributions from the account. Many HSAs even offer debit cards to make purchasing prescriptions easier and convenient. However, you’ll need to keep strict records and receipts for all qualifying medical expenses to avoid paying taxes on them. If you withdraw a distribution for a non-qualifying expense, you will be charged taxes as well as a 20% penalty fee if you are younger than 65 years old. After 65, you will only have to pay taxes.
The Pros and Cons of HSAs
Starting off with the Pros, the best thing about these accounts are the tax advantages. As long as you use the funds for qualified medical expenses and contribute no more than the max allowed, you don’t pay any taxes on funds going in or coming out. Another benefit to an HSA is that anyone can contribute to your HSA. As previously mentioned, you can contribute, your employer may help contribute, or even friends and family can help but in accordance with the limitations. There are also a wide variety of qualifying expenses. Obviously, they must be medical in nature but the list is long and you can review the full list of Qualifying Medical Expenses here. However, another great feature about these expenses is that you don’t need to claim the expenses at the time they are incurred. You can actually claim the expenses anytime after they have been made, so you can let the funds grow in your account longer and only take the money out when you need it. Also, an HSA is much like a bank account in the fact that you can maintain your HSA even if you change jobs, insurance, etc. Any funds kept in a qualifying HSA will remain there, even if your situation no longer allows you to qualify for an HSA. You just can no longer make any new contributions. They can also offer a level of convenience, with many offering Debit Cards to simplify purchasing prescriptions.
Of course there are some Cons to HSAs as well. The first is that only certain people are eligible. As mentioned above, you must have a High-Deductible Health Plan and meet the other requirements to use one. Also, there is a limit to how much you can contribute per year. As mentioned above, in 2022, the limit for individuals is $3,650 and $7,300 for families. Another burden is that an HSA requires a high level of Record Keeping. In order to get the deductions for qualifying expenses, you need to keep detailed receipts to be able to justify and claim your expenses. It can become very complicated. Also, if you accidentally spend the money on a non qualifying expense before 65 years of age, you will have to pay taxes and a 20% penalty fee. After 65, you will only have to pay taxes.
PROS
Pre-Tax or Tax Deductible Contribution
Tax Free Withdrawals for Qualified Distributions
Wide Variety of Qualifying Expenses
Expenses can be Claimed Anytime
Can Maintain HSA even if your Personal Situation Changes
Level of Convenience
CONS
High-Deductible Health Plan and Eligibility Requirements
Contribution Limits
High Level of Recordkeeping Required
20% Penalty for Non-Qualified Distributions before age 65
The Wrap-Up
So, those are the basics of a Health Savings Account (HSA). Things worth taking away from this are;
You must have a High-Deductible Health Plan to be Eligible for an HSA
Funds going into an HSA and those Withdrawn for Qualifying Expenses are Tax Free
Contributions can be made by Anyone, but Limitations Apply for Total Amounts
You can Maintain your HSA even if you no longer qualify to make contributions
There are Fees for Non-Qualified Withdrawals
Must keep Diligent Records for all Expenses Withdrawn
As you can see, there are many benefits with an HSA. Although only certain individuals are eligible, an HSA can be very beneficial if you are able to open one. Even if you never take the funds out, your HSA can continue to grow and you can withdraw if after 65 without penalty. You’ll just have to pay taxes on the withdrawal like you would with a Traditional IRA. If you’re eligible, an HSA may be a smart decision for you. If you are not sure, speak with a certified tax professional or financial planner to determine if it’s right for your financial situation. As always, Financial Literacy is the Number 1 Key to Financial Success! Keep learning!
*Disclosure* This is NOT financial advice and I am NOT a Certified Financial Planner. All information is provided for educational purposes only and is not to be construed as advice. Everyone’s financial situation is different and requires individualized planning. Seek out a Certified Financial Planner for assistance with your own financial situation.
