There are lots of initials and acronyms in the health insurance industry, but one common set of initials used more frequently these days is HSA, which stands for health savings account. This increasingly popular choice among consumers (and employers that offer health benefits) allows you to set aside money in a tax-advantaged account to cover the cost of medical care each year. There are rules and regulations surrounding HSAs, and not everyone can or should use one. Wondering if an HSA is right for you? Let’s look at some of the pros and cons.
What is an HSA?
Health savings accounts allow you to set aside pre-tax dollars to pay for qualified medical expenses. Because you put the money into a savings account before taxes are deducted, you can lower your overall health costs, and withdrawals won’t get taxed as long as you use the funds to pay for medical care. You must have a high-deductible healthcare plan (HDHP) to qualify for a health savings account. The IRS sets limits on what counts as a high-deductible health plan and caps how much you can contribute to the plan per year.
In 2018, a health plan had to have an individual deductible of at least $1,350 for the year to qualify as an HDHP (double this amount for family plans). You can place up to $3,500 for an individual or $7,000 for a family into an HSA in 2019, up from 2018 limits of $3,450 for individuals and $6,900 for families.
How Does it Work?
A health savings account works similar to the way a 401(k) or other retirement account works. You make contributions each pay period or annually to pay for future major medical costs. What you don’t use that year remains in the account and is invested, growing tax-free money. If you must withdraw the money for anything other than medical costs and you’re not yet 65, there is a 20 percent penalty. Employers may offer this type of account as an employment benefit or you may contribute to one on your own, claiming the contribution as an “above the line” deduction when you file your taxes.
It’s important not to confuse a health savings account with a flexible spending account, which may be offered by your employer. With a flexible spending account, you do not own the account. Flexible spending accounts are owned by your employer, you can’t invest money in the account and funds do not rollover each year.
Highlights of HSAs
One of the biggest benefits to an HSA in 2019 is the tax benefits. If you make contributions through your employer, they’re taken from your check before taxes get withheld. This means that the amount on your paycheck lowers, which lowers the amount that gets taxed. If you add money to an account on your own, you can deduct them from your gross income when you file your income taxes at the end of the year. In addition, anything you earn on the investment of funds is also tax free.
As long as withdrawals are used to pay for qualified medical expenses, there’s no penalty for withdrawal. You can withdraw funds for deductibles, copayments or other expenses that are not covered by your major medical insurance. If the funds are used to pay medical bills, there’s no penalty for withdrawal and you won’t be required to pay taxes on the funds you used.
Rollover and Portability
Another benefit to health savings accounts is that if you have money left in the account at the end of the year, it rolls over into the next year. This is different from a flexible spending account, which requires you to use all the funds placed in the account by the end of the year. Even if your coverage changes because you change jobs, as long as it’s a high-deductible plan and you change jobs or retire before you reach age 65, funds that are in your account continue to grow tax-free.
Access to Funds
Many health savings accounts provide you with a debit card that allows you to access the funds as you would any regular source of funds, like a bank account. If you need to pay for prescriptions or doctor visit, or meet a deductible, you can use the debit card to access your account. Healthcare providers may offer the option of paying a bill by phone with a debit card as well. You can even use the card at an ATM to access cash if your healthcare provider does not accept credit or debit cards. Unlike a 401(k) account or other type of investment account, HSAs give you easy access to your money so you can use it when you need (to cover medical bills).
High Deductible Requirement
There are disadvantages to HSAs, though. One of the biggest drawbacks is that you must have high-deductible major medical coverage. Although this type of coverage has lower premiums, it may be difficult to come up with the deductible even with money in an HSA if you’re facing a significant medical problem all at once. Paying a $5,000 deductible upfront can be difficult or even impossible for the average American family.
Since money for the HSA gets deducted from your salary each pay period, that’s also money you won’t have in your household budget each month. If the deductible is significant for your Obamacare plan, you may need to place a larger amount each pay period into your HSA in order to cover costs that might cause you some financial difficulty.
Not Enough Funds
Once the amount in your health account has been depleted, you can no longer use it to pay for healthcare costs. If you didn’t deduct enough from your salary, your medical costs could exceed the amount in your account. That means you’d be responsible for any excess costs for the rest of the year, directly out of your own pocket. With reports of increases in premiums and deductibles expected in the ACA 2019, the amount you need to add to your health savings account could be significant.
Failure to Seek Medical Treatment
If you have high-deductible health insurance in 2019, you may be reluctant to seek medical treatment, even if you have an HSA. You may feel as if you need to keep the funds in the account for retirement or that your medical condition is not serious enough to warrant a withdrawal. It’s important to understand that the account is there to offset the higher cost of your health insurance and you should use it to seek medical care no matter how minor you feel the injury or illness may be.
After Age 65
Once you reach age 65, you’re no longer eligible to put funds into a health savings account if you have Medicare. At age 65, you automatically become eligible for Medicare. If Medicare is the only health insurance you have, you can no longer contribute to the account as Medicare is not considered a high-deductible plan. If you’re nearing your 65th birthday and you still have an HSA account, you’ll need to stop contributing to your health savings account. Otherwise, the IRS can enforce penalties for excess contributions since you’re not legally allowed to contribute to the account once you have Medicare.
You can, however, continue to withdraw existing funds from the account to cover medical expenses, such as premiums for Medicare Part B. You can also withdraw funds for non-medical retirement expenses without the 20 percent penalty associated with early withdrawals for the under-65 crowd, but those withdrawals may be subject to federal and state income taxes.
One other important note about HSAs and Medicare: If you delay enrollment into Medicare, make sure you stop contributing to your HSA six months before you know you’ll have Medicare Part A. That’s because Medicare Part A has a retroactive effective date of six months, and once your Medicare takes effect, your HSA contributions become illegal. You will owe penalty fees for those contributions, even though you didn’t have Medicare at the time you made them. If you’re nearing age 65 and have an HSA, talk to a financial adviser about your options.
Keep all medical receipts for monies withdrawn from your HSA because you may be asked to prove that withdrawals were for medical services. You need to keep the receipts for as long as your tax return is considered open, which is three years after you file. In some cases, you may need to keep your receipts for as long as the HSA account is open.
If you have purchased an Affordable Care Act policy that has a high deductible, putting money in a savings account designed for healthcare costs may be a way to reduce your tax burden while also allowing you to meet those high deductibles. Although this type of account has many advantages, there are also disadvantages to consider before opening an HSA.