Health savings accounts have been around since 2003, so they’re hardly a new concept. But since healthcare policy has changed so much over the past few years, they’re getting renewed attention. Some people who have only relied on traditional health insurance to pay their medical bills might be thinking about adding an HSA to the mix. But what exactly is a health savings account, and how does it work?
The idea behind the HSA is relatively simple: Their purpose is to allow individuals with high insurance deductibles to set aside pre-tax dollars to pay for medical expenses. Generally speaking, any adult with a high-deductible health plan (HDHP)—and no other health insurance coverage—may open an HSA.
So, is a health savings account right for you? Let’s explore the HSA pros and cons.
What are the advantages of a health savings account?
There are many advantages to a health savings account, depending on your income or medical needs. Here are 5 pros to an HSA.
1. An HSA provides tax savings
For individuals who are expecting a larger medical expense in the coming year, an HSA plan can save thousands of dollars with triple tax savings, says Gary Franke, insurance broker and health savings account expert at Achieve Alpha Insurance, LLC in Bellevue, Washington.
Triple tax savings breaks down in the following way:
- One, you won’t have to pay taxes on the money you put into your HSA.
- Two, you won’t have to pay taxes on the money you take out of your HSA to pay for qualified healthcare expenses. (Though people younger than 65 will have to pay a penalty for any HSA funds used to pay for non-eligible expenses, so be careful!)
- Three, you can earn tax-free interest on money you keep in your HSA account. You also have options to invest the money in your account.
“I have an HSA account for myself now,” Franke says. “It saved me $1,500 off my tax bill in 2019.”
2. An HSA may cover some expenses your insurance doesn’t
HSA expenses can include a multitude of healthcare expenses that your insurance plan might not cover, such as orthodontia and eyeglasses. “There are hundreds of health expenses that qualify for payment from an HSA,” says Vikram Tarugu, MD, gastroenterologist and the CEO of Detox of South Florida. “Examples include chiropractic or dental treatments, fertility services, wheelchairs, and prescription medications.”
3. An HSA allows contributions from others
“Some people may not know this, but you can permit others to contribute to your HSA,” Dr. Tarugu explains.
According to the IRS, you can accept HSA contributions from any other person, such as your employer or a family member. This leads to even more tax advantages. The amount your employer contributes will not be counted as income for tax purposes. And if a family member contributes to your HSA, their contribution is tax deductible on the family member’s return, even if they don’t itemize deductions.
In addition, health savings accounts are pretty flexible in terms of when you deposit and spend the money. “Contributions to an HSA can be made any time during the calendar year and up to Apr. 15 of the following tax year,” says Dr. Tarugu.
Note: The contribution limits for 2020 are $3,550 for individual plans and $7,100 for family coverage. The limits for 2021 will be $3,600 for individual plans and $7,200 for family plans.
4. An HSA offers flexibility after the age 65
You can also look at HSA contributions as a form of retirement savings. After you turn 65, you can use your HSA funds to pay for any expenses, whether they are health-related or not. You will not pay a penalty, but the distribution wouldn’t be tax free.
5. An HSA allows for portability of funds
Some savings accounts, such as flexible savings accounts (FSA) are “use it or lose it.” Meaning, if you don’t use all the funds, they expire at the end of a set period, typically within a calendar year. That’s not a risk with an HSA. “You can let funds roll over to the next year,” Dr. Tarugu says. This allows for you to retain funds if you change funds or retire. Any HSA money is yours to spend on health expenses, no matter when you need it.
What are the cons of an HSA?
If you have an HSA, by definition, you also probably have a high deductible health plan. That can get pretty expensive. Here are three cons of an HSA.
1. A high-deductible health plan associated with an HSA can result in high out-of-pocket costs
With a high-deductible health plan, you’ll be expected to pay 100% of doctor visits, prescriptions, and medical procedures until you hit your deductible, Franke says. This year, an HDHP is any plan with a deductible of at least $1,400 for an individual or $2,800 for a family, according to the IRS. But with some plans, total yearly out-of-pocket expenses can be as high as $6,900 for an individual or $13,800 for a family. That includes money you spend on copays, coinsurance, and deductibles.
High deductible health plans are typically more beneficial to generally healthy people who mostly require preventive care. If you have a chronic medical condition that requires frequent doctor’s office visits and regular treatment, or if you know you have a surgery coming up, you might consider a different type of healthcare plan. Otherwise, you’ll have to pay upfront for all of these expenses, which will burn through your HSA funds pretty quickly.
2. An HSA might not cover unexpected expenses
“You might have unexpected healthcare costs, which might exceed the amount you have saved in your HSA,” Dr. Tarugu says. “Then there’s the pressure to save,” he says, referring to the reluctance some people feel in seeking care because they believe the money in their HSA might be needed at some time in the future.
3. There are rules around HSA accounts.
Some other disadvantages of HSAs include recordkeeping requirements, taxes and penalties, and fees. Whenever you withdraw money from your HSA, depending on the plan, you may have to keep receipts to prove that you spent the money on a qualified medical expense. If you are under 65 and the expense is deemed to be unqualified, you’ll have to pay taxes on the money plus a 20% penalty. Additionally, some HSAs charge a monthly maintenance fee or a per-transaction fee. This varies by institution.
Other alternatives to consider
If you have an HDHP, and that plan is offered by your employer, HSAs aren’t necessarily the only option you have for setting aside tax-free money for health expenses. You might also want to consider a health reimbursement account (HRA) or a healthcare flexible spending account (FSA).
An HRA is a type of health spending account that your employer might offer in your benefits package. Only your employer can contribute to the account, and the employer owns it. The money that your employer contributes to your HRA is not considered income for tax purposes. Your employer controls almost everything about the HRA, including which expenses it covers and whether or not to allow funds to roll over into the next year.
A healthcare FSA is another type of health spending account, usually associated with plans with lower deductibles. Like HRAs, these can only be offered by employers. As such, your employer owns these accounts too. However, both you and your employer are allowed to contribute to an FSA. One of the main drawbacks is that FSAs are “use it or lose it.” If you don’t use all of your FSA money by the end of the year (or until the following April on some plans), your employer is allowed to keep the remainder.
For a detailed explanation about all of the differences between HSAs, HRAs, and healthcare FSAs, see our blog post, “HRA vs HSA vs FSA: What’s the best health savings account?”