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Health Savings Accounts (HSAs) are an interesting asset.
While their intended purpose is accurately reflected in their name, they have a number of advantages that are difficult to ignore.
Specifically, HSAs have a number of tax advantages that go beyond the scope of saving for everyday expenses.
If used properly, they can bolster your retirement savings, reduce your taxable income, and also help address a concern for retirees: the cost of healthcare in retirement.
What Is An HSA Account and How Does It Work?
An HSA (Health Savings Account) is a tax-advantaged savings account that helps supplement medical expenses for those covered by an HDHP (High-Deductible Health Plan).
You can only have an HSA if you are already enrolled in an HSA-eligible HDHP. HSAs may be offered by your employer, or you can open one separately.
With employer-sponsored HSAs, both employer and employee can contribute, but those contributions together may not exceed the annual contribution limit (detailed below).
Another important point about HSAs is that they can be taken with you even after you leave a job. You still won’t be able to contribute more than the contribution limit to different HSAs during a given tax year, but you won’t lose contributions from your old employer.
HSA Contribution Limits
Contributions to an HSA also reduce your taxable income. However, if, for some reason, you exceed the contribution limit, you’ll incur a 6% penalty, and the excess is not tax-deductible.
Contribution limits change every year, so be sure to check the limits listed on HeathCare.gov for the current tax year.
For 2019, the HSA contribution limit is $3,500 for individuals ,or $7,000 for families. Those ages 55 and over will be allowed an additional $1,000 catch-up contribution per year. With employer-sponsored HSAs, both employer and employee can contribute, but those contributions together may not exceed the annual contribution limit.
For 2019, the minimum deductible for an individual is $1,350, or $2,700 for families. For 2020, these numbers increase to $1,400 and $2,800.
Thus, enrolling in an HDHP means you must be sure you can cover these deductible amounts – especially since these are the minimum deductibles an HDHP can have.
Every plan will have a different deductible, but you must be able to cover the entire amount. Your insurance (HDHP) will only cover what’s remaining.
So if you have a $2,000 expense and your deductible is $1,500, your insurance will only cover $500. You must cover the other $1,500.
What Can HSA be Used For?
An HSA can be used to cover certain medical expenses, known as Qualified Medical Expenses (QMEs).
Some common QMEs include:
- Birth control pills
- Contact lenses
- Dental treatment (preventative)
- Hearing aids
- Physical exam
In general, you can’t use your HSA to pay for insurance premiums. However, while the deductibles are high when you have an HDHP, the monthly premiums are low.
For a full list of QMEs, check Pub. 502, Medical and Dental Expenses from the IRS.
Do I Qualify for an HSA?
The main requirement you must meet in order to qualify for an HSA is to be enrolled in a high-deductible health plan (HDHP).
Some employers have an employer-sponsored HDHP – but not all do.
Per the IRS, you must also meet the following requirements to be eligible for an HSA:
- You have no health insurance except what is covered by other health coverage
- You are not enrolled in Medicare
- You cannot be claimed as a dependent on someone else’s tax return
Also, note that although you must have an eligible HDHP to qualify for an HSA, there are some HDHPs that do not qualify for an HSA.
If you intend to open an HSA, be sure you get an HDHP that explicitly states it is HSA-eligible.
How Can You Use an HSA as a Retirement Account?
The way you can use your HSA as a retirement savings account is fairly straightforward. You will regularly contribute to the HSA, adding to its balance. Then, when you have a QME, instead of using money from the HSA, you pay out of pocket instead.
Doing so allows the money in the HSA to continue to grow tax-free. Contributions are also pre-tax if the account is through your employer, or tax-deductible if you opened the account yourself. In other words, there is already a double tax advantage.
If you have the means of doing so, you can continue to pay for your QMEs out of pocket indefinitely. Once you reach age 65, you can begin withdrawing the money from your HSA completely tax-free if that money is used for qualified medical expenses.
If you use the money for anything other than QME, the money will be taxed as regular income. In this case, the HSA acts similarly to a traditional IRA.
Also, you should be aware of the fact that if you withdraw money from your HSA before age 65 and use it on expenses that aren’t QMEs, you’ll be charged a 20% penalty in addition to having it taxed as income. Thus, HSAs should never be used as a retirement account before age 65, aside from an absolutely dire emergency.
You could potentially decide, in retirement, to use some of the money to cover QMEs (in which case, you pay no tax), and use some of it on other expenses (in which case, it will be taxed). Thus, you’ll have increased flexibility while still saving substantially on taxes.
How Does an HSA Work in 2020?
The way HSAs work in 2020 will not be any different from how they work in 2019 or before. The only thing that changes from one year to the next is usually the minimum deductible and contribution limits. In 2020, the contribution limits for HSAs will be $3,550 for individuals and $7,100 for families.
Deductibles must be at least $1,400 in 2020 or $2,800 for families. Yearly out-of-pocket expenses cannot exceed $6,750 for individuals, or $13,500 for families.
The catch-up contribution (age 55 & over) remains unchanged at $1,000.
You must contribute to your HSA with cash – this can be a payroll deduction or money you put in manually. Self-employed people who meet the HSA requirements can also make tax-deductible contributions to an HSA.
Flexible Spending Account (FSA) vs. HSA
While these two accounts have similar acronyms, it’s important not to confuse the two.
While they appear similar at first, there is a very important difference between them: the FSA is a “use it or lose it” account. In other words, if by the end of the tax year you haven’t used the money in this account, you forfeit the remainder of the balance.
HSAs don’t work like that. You are permitted to roll funds over from tax year to tax year, and you’ll never lose money simply because you didn’t use it.