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Health Savings Accounts: A Great Way to Save on Medical Costs Now and in the Future

By Jane Leibbrand

First set up in 2003, Health Savings Accounts (HSAs) are relatively new vehicles to help individuals save money on medical costs and health insurance. They’re growing in popularity. In 2017, about 22 million Americans had an HSA, and that’s up 9 percent from 2016.[1]

Tax Advantages

An HSA has a triple tax advantage, which makes it attractive for many individuals. Most employers allow you to contribute to your HSA through tax-free payroll deductions. This allows you to take advantage of the tax savings immediately. You may also contribute directly with post-tax dollars, and then deduct those amounts when you file your taxes. Regardless of how you contribute, putting dollars into your HSA lowers your taxable income. Second, any interest earned is not taxed—ever. Third, when you withdraw the money you’ve saved in your HSA for qualified medical expenses, it’s tax-free. You’ll never pay tax on the money in an HSA if you follow IRS guidelines.

Following are important rules and requirements about the type of health care plan an HSA stipulates you must have, what counts as qualified medical expenses, paying premiums, rules on contributions, and key pros and cons of HSAs.

Enrollment in a High Deductible Health Plan

The Basic HSA Requirement: A High Deductible Health Plan

To set up an HSA you must be enrolled in a qualified high deductible health plan (HDHP) and not be covered by another health insurance plan or enrolled in Medicare.

What’s the difference between a high deductible health plan and another type of plan? Just as the name implies, your deductible is significantly higher than the deductible under a regular health care plan. However, the monthly premiums you pay (usually taken out of your paycheck by your employer) are typically much lower than those of other health insurance plans. So there are tradeoffs you need to think about if you’re considering enrolling, and if your firm provides a choice between types of plans. Some companies now offer an HDHP with an HSA in addition to a traditional health insurance plan, while other companies offer only one or the other.

The High Deductible Doesn’t Apply to Your Preventive Care

Preventive care needs, such as annual physical exams, vaccinations, and screenings like colonoscopies or mammograms within recommended age brackets, are covered without regard to the deductible in an HDHP. HDHPs follow age and gender screening recommendations by the U.S. Preventive Services Task Force.

Amount of Deductible Before Accessing HSA Funds

For other types of common expenses such as an X-ray for a broken bone, an MRI, any doctor’s visit that isn’t a preventive care visit, or any type of surgery, you must meet the deductible before care is covered on your health plan.

The IRS determines the deductible minimums for HDHPs. For 2019, the deductible is at least $1,350 for an individual or $2,700 for a family. The IRS also sets an upper limit for the amount you pay per year for services under the plan. In 2019, deductibles, co-pays, and coinsurance are limited to no more than $6,650 for a single person and $13,300 for a family for in-network services. If you see a physician or use a provider not in the network, the limit no longer applies. 

Qualified Medical Expenses

Health Expenses That Can Be Paid With an HSA

You can withdraw the money you save in your HSA for qualified medical expenses. The IRS determines what a qualified medical expense is. It’s pretty straightforward, in that the expenses must be directly related to helping or preventing physical or mental illness—for example, doctor and hospital bills. Dental and vision expenses are also included under the HSA umbrella of qualified expenses, and that includes hearing aids, eyeglasses, and contacts. Breast pumps are covered, but not the extra supplies.

Many benefits for special populations are included as qualified medical expenses. Your HSA funds can pay for services ranging from guide dogs to the costs of a child’s special school that treats significant learning disabilities. If you have a question about a specific expense, see IRS Publication 502, Medical and Dental Expenses, and check out the laundry list of what’s included as a qualified expense that your HSA funds will cover.

Nonallowed Expenses Under an HSA

Not all health-related costs are qualified medical expenses. For example, you may belong to a gym, which is great for your health, but it isn’t a qualified expense. Neither are maternity clothes, toothpaste, or toiletries, although you may need them!

Paying for Health Care Premiums

HSA money cannot generally be used to pay your health insurance premiums. They’re normally classified as nonmedical withdrawals and would be subject to taxes and a penalty.

However, there are important exceptions for types of premiums and/or special circumstances for which you may be eligible. You can use your HSA to pay premiums on the following without any penalty or extra taxes:

  1. Qualified long-term care insurance;
  2. Health insurance if you’re currently receiving federal or state unemployment compensation;
  3. Continuation of health plans (e.g., COBRA) required under federal law; and
  4. Medicare premiums.[2]

The exception for those on Medicare covers a huge swath of the population—all those over 65 who are on Medicare.

If you’re on unemployment, remember that when it ends you can no longer use your HSA to pay your premiums—it’s meant as a temporary help.

HSA Contributions

How Much Can I Contribute to an HSA Each Year?

The IRS determines contribution limits. In 2019, individuals can contribute up to $3,500 annually, and $7,000 is the maximum per year for families. Add $1,000 if you’re 55 or older by the end of the tax year (April 15). You can contribute on a regular schedule or simply make a one-time contribution for the entire year.

Many employers contribute to their employees’ HSAs. If your employer contributes, you’re saving money, because your employer is subsidizing part of your $3,500 or $7,000 annual contribution.

Pluses and Minuses of HSAs: Considerations

Now that you know the basics of HSAs, what follows are some of the advantages and disadvantages. 

The Pluses

Tax Savings - The big advantage of an HSA: the triple tax advantage. HSAs are totally tax-free, and that means you’re saving money.

Use for Future Medical NeedsAny unused money in your HSA automatically rolls over to the next year, unlike flexible spending accounts, which generally are “use or lose” within a calendar year.

Once you have enough money in your HSA, you can save money not only on current medical costs, but also on future expenses. For example, if your doctor has told you that you’ll probably need a knee replacement in a couple of years, the money you save during the next two years can defray most if not all of the costs of the surgery when it takes place, assuming you don’t have high medical costs in the interim and need to use the money saved before having the knee replacement.

More good news—if you change employers or retire, your money still grows tax-free and is in your account for future medical costs.

An Additional Savings Vehicle - If you’re in early or mid-career, after you contribute to your 401k up to the match, contributing to an HSA up to the cap is your next best savings move because of the tax advantages, says Meryl Golder, manager, human relations, Business Operations Group at CAPTRUST. Then you can add any discretionary money left over to the 401k.

Golder notes that high earners may use HSAs as another retirement savings vehicle. If you can afford to pay for many of your medical expenses out of pocket, you can simply save up your HSA contributions and build a nest egg for medical expenses in retirement. Medical costs generally go up as you age; health care will likely be one of your biggest expenses in your later years. Financial experts estimate that a couple will spend about $280,000 on health care costs during retirement—depending, of course, on your individual health and how long you live.[3]

Convenience - Your HSA usually comes with a debit card so you can pay your doctor bill on the spot or make a phone payment later using the card. You can also pay out of pocket and reimburse yourself from your HSA if the expense was incurred while your HSA was open. Plus, it functions like any other debit card, dispensing cash at an ATM.

Multiple Contributors Are AllowedFinally, if others in your family want to contribute to your HSA—maybe a parent or grandparent—they can do so, saving you more money.   

The Minuses

Having a High Deductible - If you’re on a strict budget, it might be hard to come up with money for an expense before you meet your deductible. As an individual, you’ll pay $1,350 in cash or on a credit card before you can access your HSA savings for costs that aren’t preventive care.

If you’re anticipating a large medical expense in your first year contributing to an HSA, you’ll want to make sure you understand your financial liability so you’re prepared if you don’t already have that amount saved in your HSA, advises Golder. 

Significant Unexpected CostsIf you or someone in your family has an accident or a serious illness, your HSA might not cover all of those costs, especially if it happens in the first year you’re enrolled.

Penalties for Nonqualified Expenses - If you forget to check whether an expense is allowed and use funds on a nonqualified expense, you’ll pay taxes plus a 20 percent penalty if you’re under 65 years old. If you’re 65 or over, you’ll owe the tax, but the penalty is forgiven.

Keeping Receipts - You’ll need to keep receipts for your qualified medical expenses in case you’re ever audited, and it’s a good idea to keep your explanation of benefits statements from your health insurance company as well. An easy way to do this? Simply use an app to scan them and keep them in the cloud.

Upon reading the information above, you may have already decided that an HSA is for you, or conversely, that it’s not appropriate. If you’re single, young, and healthy and you’re not incurring high medical costs, an HSA could be a great way to save a significant amount for the future when you have a family and have new types of health expenses. On the other hand, if you’re not a record-keeper, tend to lose receipts, and don’t use technology, maybe an HSA isn’t for you unless you have a significant other who can take over these administrative details.

How Do I Set Up an HSA?

Once you’ve enrolled in a high deductible health plan, you can contact the human resources department of your company to help you enroll in an HSA. The company may direct you to a bank it recommends. If you’re not with a company that has a human resources department, check with your bank or credit union or any reputable financial institution; if they offer HSAs they’ll explain how to enroll.

Have questions? Need help? Call the CAPTRUST Advice Desk at 800.967.9948 or schedule an appointment with a financial counselor today.

[1] Donaldson, Cathryn, “More Americans Choose a Health Savings Account with a Consumer-Directed Plan for Their Financial Security,” 2018

[2] HSACenter.com, "Frequently Asked Questions," 2018

[3] Fidelity Viewpoints, “How to Plan for Rising Health Care Costs,” 2018