If you want to save for medical expenses and reduce your taxable income at the same time, opening a health savings account (HSA) is a great option. However, it may not be the best fit for you, depending on your situation and insurance policy.
Let’s look more closely at how HSA’s work, and the pros and cons of opening one.
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What is a Health Savings Account (HSA)?
An HSA is a savings account that you can only use to pay for qualified medical expenses. The money you deposit into an HSA isn’t taxed, and you control the funds, not your insurance company.
If you’re enrolled in a High-Deductible Health Plan (HDHP), you’re eligible to open an HSA. An HDHP is an insurance policy with a higher than normal deductible.
Your premium may be low, but you’ll have to pay a hefty deductible before your insurance company pays anything. According to the IRS, individuals with a deductible of $1,400 and families with a deductible of $2,800 qualify as an HDHP.
If you’re a healthy individual with few medical expenses, an HDHP may be a good choice for you. HSAs can also be a good option for retirees to help offset some of the medical costs.
What are the Tax Advantages?
Here are the three tax benefits you’ll receive for opening an HSA:
- The money you contribute is not subject to federal income taxes
- Any interest you earn from the HSA is not subject to federal income taxes
- The money you withdraw is not subject to federal income taxes, assuming the purchase is for a qualified medical expense
Pros and Cons
Like anything, there are advantages and disadvantages to using an HSA. Let’s look at some of the biggest pros and cons below.
- More control: One of the biggest advantages of an HSA is that you have more control over your medical expenses. You own the account and can decide how the money is spent. And if you don’t spend it all by the end of the year, it automatically rolls over into the following year.
- Employer contributions: Your employer may contribute to your HSA as part of your employee benefits package.
- No taxes: Any money you deposit into your HSA is tax-free. And if you earn interest on the money in your HSA, that’s tax-free as well. And if you use the funds for qualified medical expenses, your withdrawals are tax-free as well.
- Convenient: The money you put in your HSA is easy to access and use. Most insurance companies will issue you a debit card so that you can pay for necessary expenses immediately.
- Investment opportunities: In addition, the money you put in your HSA can be invested in mutual funds or other investment vehicles. But if you plan to do this, you’ll need to find an HSA custodian to manage your investments.
- High deductible: To qualify for an HSA, you have to agree to an insurance plan with a high deductible. For a family of four, paying $2,800 or more out of pocket for a necessary medical procedure can feel very out of reach.
- Taxes: If you use the money in your HSA for non-qualified expenses, you’ll have to pay taxes on it.
- Possible fees: Some HSAs charge either a monthly maintenance fee or a per-transaction fee. This fee will likely offset any interest you earn with the account. You may be able to get the fee waived if you can maintain a minimum balance in your account.
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When you use the funds in your HSA, you want to make sure you only use them for qualified medical purchases. Otherwise, you’ll have to pay federal taxes on your withdrawal.
However, the regulations that govern these accounts are updated frequently, so it’s hard to know what is considered a qualified expense. This list is not all-inclusive but can serve as a guide to help you get started.
Here are some of the IRS-qualified expenses:
- Birth control
- Blood sugar test kits
- Dental treatments
- Drug prescriptions
- Flu shots
- Physical therapy
- Over-the-counter (OTC) drugs
- Vision exams
However, if an item is not listed as an IRS-qualified expense, you may be able to get it approved with a letter of medical necessity. For instance, weight loss programs, CPR programs, or special home equipment may be eligible with a letter of medical necessity.
How Do I Get Started?
If you’re interested in opening an HSA, you can do it through your employer or a financial institution. However, there are a few things to keep in mind.
First, HSAs are only available to individuals under the age of 65. Once you’re enrolled in Medicare, you can’t continue making contributions to your HSA.
Also, the IRS puts limits on how much money you can contribute each year. Individuals can contribute up to $3,600 per year, and families can contribute up to $7,200 per year. If you’re between the ages of 55 and 65, you can make additional catch-up contributions of $1,000 per year.
The Bottom Line
If you’re enrolled in an HDHP, you automatically qualify for an HSA. HSAs can be a great option, thanks to the tax benefits, and they can give you more control over your medical care.
Have you ever used an HSA? If so, what was your experience like? Let me know in the comments!