One of life’s great pleasures is tax-free investing. An account that offers you the chance to truly take advantage of tax-free money is the Health Savings Account (HSA).
Let’s take a look at the HSA and how you can use it to improve your financial situation.
What is a Health Savings Account (HSA)?
An HSA is a tax-advantaged account designed to help consumers save for qualified medical expenses. Contributions to the HSA are made before tax. When you use the money for eligible expenses, you can withdraw the money without paying taxes. As a result, when used as designed, you can pay for healthcare costs with truly tax-free money.
Before you get too excited, though, it’s important to understand some of the requirements associated with the Health Savings Account.
Who’s eligible for an HSA?
You must have a high-deductible health plan (HDHP) to qualify for a Health Savings Account. When looking at your company’s offerings or searching for a plan for an exchange, you need to pay attention. Make sure the plan qualifies for an HSA. Usually, the plan itself mentions HSA somewhere in the plan name.
Additionally, with a few exceptions, you can’t be enrolled in Medicare, be claimed as a dependent on someone else’s tax return, and you can’t have other health coverage.
How much can you contribute to an HSA?
The amount you can contribute to a Health Savings Account is based on a couple of factors:
- How much the IRS allows you to contribute each year (similar to contribution limits for other accounts).
- Whether you have a family plan or an individual plan. A family plan comes with a higher contribution limit.
There are no income thresholds or phaseouts.
What can you spend HSA funds on?
You can use HSA money for such expenses as:
- Certain over-the-counter medications
- Prescription medications
- Exams and procedures that might not be covered by regular health insurance (like dental and vision costs)
- Medical equipment (like crutches and certain monitors)
- Medicare premiums (even though you can’t contribute once you’re on Medicare, you can use money in the account to cover costs)
The IRS offers a list of qualified expenses. There’s no time limit on these items, so you can use the money immediately for costs you accumulate today or save receipts and get reimbursed later.
Watch out for penalties
As with most tax-advantaged accounts, there are penalties when you go outside the approved use of an HSA. If you withdraw the money for non-qualified costs, you’ll be stuck paying a 20% penalty on top of being taxed. Later, after age 65, it’s possible to withdraw money for non-qualified medical expenses without a penalty. However, you’ll have to pay taxes on that money.
Strategies for Making the Most of Your Health Savings Account
Your HSA money rolls over year to year—unlike an FSA or HRA, which are use-it-or-lose-it propositions each year. Because the HSA rolls over, you can build a tidy healthcare emergency fund. You can invest the money you put in an HSA, and it will grow tax-free over time.
Invest a portion of your HSA dollars
Review different HSA providers and find one that allows you to invest a portion of your HSA funds. This money will be kept in a separate investment account. You can choose from various stocks and funds. Over time, the money can potentially grow. Later, the money can be used to:
- Pay healthcare costs during retirement
- Cover your out-of-pocket expenses for major procedures
- Be a backup IRA during retirement, after you reach age 65
Forced savings for later
If you can afford to pay your out-of-pocket healthcare costs today, use the HSA as a forced savings account. Save all of your receipts. Later, when you want a chunk of capital, you can “cash in” all those receipts. You need them for tax purposes. But over the years, the amounts can add up. Taking all the reimbursements at once is possible, resulting in a decent chunk of capital you can use for various purposes.
Should You Open an HSA?
While a Health Savings Account can be a great tool, it’s not for everyone. For example, if you have a lot of ongoing healthcare costs, it might not work. The high-deductible plan might not cover some of the high care costs for recurring conditions.
Depending on your situation, paying a higher monthly premium so that you have lower out-of-pocket costs for regular care might make more sense. In many cases, an HSA works well for those who don’t have a lot of healthcare needs and want a bare-bones policy with a low premium. You can save the difference in premium costs in an HSA when you need to meet your high deductible.
Carefully consider whether an HSA works for you and your family, and make your choices accordingly.