Whether you’ve lost your job, left your job, or are looking to save money, a high-deductible health plan (HDHP) can help lower your premiums. It may also open up a new tax-saving option for you—a health savings account (HSA).
It’s not a great arrangement for everyone, as a high deductible can leave you with a lot of out-of-pocket medical expenses. However, if you have an emergency fund or can’t afford a lower-deductible plan, combining a high-deductible plan with an HSA can lead to long-term savings.
The Three Main Benefits of an HSA
Health savings accounts are a type of tax-advantaged account, similar to retirement accounts. But they offer even better tax savings.
With a retirement account, you have to choose to pay the taxes now (a Roth account) or later (a traditional account). But you never pay taxes on the money you contribute to an HSA if you spend it on approved medical expenses later.
Here’s how it works:
- The money you contribute to your HSA is an above-the-line tax deduction. In addition to decreasing your tax bill, the deduction will lower your adjusted gross income (AGI) and could make you eligible for more tax credits and deductions.
- You don’t pay any taxes on the interest or investment earnings while the money is in the account. You can keep your HSA funds in a savings account to earn interest. Or, some companies offer HSAs that allow you to invest the money.
- You won’t pay taxes on withdrawals if you spend the money on qualified expenses.
In short, you’ll never pay taxes on the money if you spend it on qualified medical expenses. And, in the meantime, you can earn interest or investment income on the money.
Although, as with other tax-advantaged accounts, there are penalties for withdrawing money when you don’t have a qualified expense. You’ll have to pay income taxes on the money, and, if you’re younger than 65, pay an additional 20% penalty.
What Are Eligible HSA Expenses?
The list of qualified expenses is fairly comprehensive and includes everything from bandages or glasses to prenatal, psychiatric, and nursing care. It starts on page nine of IRS Publication 969, but companies that offer HSA accounts may have clearer lists of eligible HSA expenses.
HSAs complement high-deductible plans because you can use the HSA money to pay for deductibles, copayments, and coinsurance.
While health insurance premiums generally don't qualify, you can use the funds for premiums if you're receiving unemployment, paying for long-term care insurance or COBRA, or are over 65 and paying for supplemental Medicare policies.
One interesting component of the HSA is that you don’t have to take the money out of your account right away.
For example, if you have a medical procedure today and can use other savings to cover the expenses, you can leave the money in your HSA to continue earning interest. You can still use that same receipt to take the money out of your HSA in the future without having to pay taxes on the withdrawal. With this in mind, your HSA could double as an emergency fund or be part of your retirement plan.
Qualifying for an HSA
While HSAs offer potential benefits, they’re not available to everyone. And, like other tax-advantaged accounts, there’s a limit to how much you can contribute to your HSA each year.
- You must be at least 18 years old and have a high-deductible health plan. As of 2020, your plan must have a minimum deduction of $1,400 for an individual plan or $2,800 for a family plan.
- You can’t be someone else’s dependent for tax purposes.
- You can’t have other health insurance, such as Medicare or Medicaid. Although, you may be able to have certain types of separate plans for vision, dental, or long-term care.
You can contribute up to $3,550 into your account each year. The limit doubles if you have a family health insurance plan, and you can contribute an additional $1,000 if you’re 55 or older. If you only qualify for part of the year, you can open and contribute a prorated amount to an HSA.
The rules are more complicated if you’re married as you can’t have a joint HSA account. Instead, if you both qualify, you can both open and contribute to your own HSAs. If you have separate, self-only health insurance policies, the same limits apply. If one of you has a plan that covers children and the other has a self-only plan, the combined limit for both HSAs is still $7,100 (two times $3,550).
Opening and Managing Your Account
If you have an HDHP from your employer, the company may also help you set up your HSA. Some companies also offer matching HSA contributions. Although you can’t deduct that amount from your income, it’s free money that you can use for medical expenses later.
Whether you’re self-employed, unemployed, or don’t like your company’s offering, you can open an HSA on your own. (You can also move money between HSAs if you find a better option or change jobs.) You can find options from banks, credit unions, and online companies that specialize in HSAs.
While the tax benefits will be the same, there may be different fees, interest rates, and investment options. Research your options online before opening an account. Then, review your budget to determine how much you can contribute and save for your future medical expenses.