What Is an HSA?

A health savings account, or HSA, is a tax-advantaged account that allows account holders to save for qualified medical expenses, such as dental services or vision care, that are not reimbursed by high-deductible health plans. Apart from being handy for saving on medical costs, HSA is also useful for reducing taxable income.

If you’re wondering how a health savings account (HSA) works and whether you are eligible to open it, read our guide and find all the answers here.

Do You Qualify for an HSA?

An essential requirement that makes you eligible to save money to an HSA is that you must be enrolled in a high-deductible health plan (HDHP).

Those health plans are refined every year by the Internal Revenue Service (IRS), which establishes the minimum deductible and maximum deductible amount that a plan holder can spend with their own money per year. The financial benefit of an HDHP’s low-premium and high-deductible plan depends on your personal circumstances.

In the 2022 tax year, the minimum deductible amount required to open an HSA is $1,400, with a maximum out-of-pocket spending of $7,050 for an individual. In the case of families, the minimum deductible is $2,800, while the maximum limit is $14,000. In the 2023 tax year, the deductibles for self-only coverage will be $1,500 and $3,000 (minimum and maximum), while the deductible amount for family coverage will be $7,500 and $15,000 (minimum and maximum).

As mentioned earlier, people with high-deductible health plans (HDHPs) are eligible to open health savings accounts (HSAs). An individual with HDHP may qualify for an HSA, ad those two accounts are usually paired together.

For an individual to be eligible to open an HSA, they must meet certain eligibility requirements established by IRS.

An eligible individual:

• Has a qualified HDHP
• Does not have other health coverage
• Is not a dependent on someone else’s tax return
• Does not pay Medicare premiums

Note that although some plans may have deductible amounts, they do not qualify you for an HSA plan. If you are looking for the account option, make sure you look at plans specifically tagged “HSA-eligible.”

How Does an HSA work?

Certain employers who offer high-deductible health plans also offer health spending accounts. If your employer doesn’t offer it, you are able to open a separate HSA as long as you have a qualifying plan.

Every year, you determine the amount of your pre-tax contributions to your HSA. However, you cannot exceed the contribution limits that are mandated by the government.

The maximum contribution for health savings account in 2022 is $3,650 for an individual and $7,300 for a family. In 2023, the annual limit will go up to $3,850 for self-only coverage and $7,750 for family coverage. Those limits apply to the total amount contributed to an HSA by both the employee and the employer. Individuals who are over the age of 55 by the end of a tax year can make additional HSA contributions of $1,000 to their retirement accounts.

If you have an HSA established through your workplace, you can set up automatic payroll deductions from your account. Your HSA funds will be linked to a debit card or checks, and you will be able to use them on qualified medical expenses.

Individuals who enroll in Medicare are no longer able to contribute to an HSA from the first month of enrollment. However, they are eligible for getting tax-free distributions to pay for qualified medical expenses.

When an individual covers the costs of eligible medical expenses equal to a plan’s deductible amount, additional qualified expenses are covered by both the individual and the plan. The insurer normally covers 80% to 90% of the expenses, while a plan holder pays the remaining 10% or a co-pay specified in the plan.

What Can Be HSA Funds Used for?

Eligible medical expenses include deductibles, co-pays, co-insurance, dental care, vision care, prescription drugs, over-the-counter medications, psychiatric treatments, feminine hygiene products, and other qualified medical expenses that are not covered by a health insurance plan.

Among the costs that do not count as qualified medical expenses are health insurance premiums unless they are for Medicare or similar healthcare coverage (as long as you are 65 or older), for health insurance coverage when receiving health continuation coverage or unemployment compensation, or for long-term insurance subject to annual limits.

If distributions are made from an HSA to cover the expenses that are not qualified as eligible, you will need to pay income tax on that amount, as well as an additional 20% tax penalty. However, once you turn 65 years old, the tax penalty is eliminated, and only the income tax is applicable to unqualified expenses.

Pros and Cons of an HSA

Pros

• Tax-free contributions. The HSA contributions are either pre-tax money (through an employer) or tax-deductible (through your own contributions). Therefore, the more HSA dollars you save, the less federal income tax you will be subject to.
• Tax-free account growth. You can invest your HSA money in stocks, mutual funds, and other securities. Depending on your investing preferences, there are different companies that can help you do this. It’s crucial to find an HSA custodian who offers low-fee investment options.
• Tax-free withdrawals. HSAs allow for withdrawing your money without having to pay taxes, as long as it is used for eligible health care expenses.
• HSA funds roll over to the next plan year. Unlike a flexible spending account (FSA), your HSA balance is carried into the next tax year, so you do not have to worry that any of your unused funds will be lost.
• Your employer can contribute to your HSA. An employer may choose to put funds toward the HSAs of eligible employees. Over 80% of employers offer this benefit, and the contribution counts toward employees’ contribution cap.

Cons

• You must have a high-deductible health plan. In order to be qualified for an HSA, you will need to have sufficient financial resources to manage substantial deductibles until your insurance starts covering your eligible medical expenses. You cover all healthcare expenses out of your pocket until your reach the specified deductible amount.

The Bottom Line

Health saving accounts offer great tax advantages as the contributions are not subject to income tax. HSAs offer non-taxable withdrawals for eligible medical expenses. They also allow for funds to be invested and grown tax-free.

As we age, healthcare expenses tend to increase, especially after we hit retirement age. Therefore, opening an HSA early and allowing it to accumulate over a long period of time can be helpful in providing your financial stability.

When deciding whether saving to an HSA is a suitable option for you, it’s crucial first to determine your medical needs and next consider your savings and investment needs. If you’re opting for an HDHP for your health care, an HSA can be a valuable tool to add to your plan.

Health Savings Account FAQs

Can I have a health savings account (HSA) if I’m self-employed?

Yes. If you’re self-employed and have a high-deductible health plan, you are eligible to open an HSA. Carefully research the options available to get yourself the best deal to suit your needs.

Do I need to use all my HSA funds every year?

No, you don’t. Unlike FSA, a health savings account allows you to roll your contributions over to the next year. As you can also invest the funds into your account, you have the opportunity to build substantial capital for more costly medical expenses or use it as an investment fund after you retire.

Can I pay for my insurance coverage with my HSA money?

Normally you will not be able to pay your insurance premiums with your HSA funds, as they can only be used to cover eligible medical expenses.

However, the only exception is if you use the funds to pay Medicare premiums or similar healthcare continuation coverage, while you are on unemployment compensation. You can also cover the costs of your long-term care insurance with your HSA funds.