10 Things to Know About a Health Savings Account (HSA)

Valuable Information to Help You Determine if an HSA Is Right for You

Physician talking with a patient about her HSA
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Larry Williams / Getty Images 

Health savings accounts are employer-sponsored health plans that were created by federal legislation in 2003. An HSA is much like a savings account and is typically maintained and administered by banks or insurance companies.

An HSA offers triple tax savings by reducing taxable income upon contribution, earning tax-free gains and income while invested, and allowing tax-free withdrawals for qualified medical expenses. This can be extremely beneficial to employees should they need to pay off a hefty bill for a medical emergency. An HSA will also cover a variety of health expenses that aren’t covered by traditional employee health insurance.

While it sounds great to have a plan that offers such valuable tax savings and a wide array of services, it’s important to understand all of the details of an HSA before determining whether it’s right for you. 

Key Takeaways

  • A health savings account (HSA) is an employer-sponsored health plan that is much like a savings account and is typically maintained and administered by banks or insurance companies.
  • Whether you are an employee or self-employed, you must be covered by a high-deductible health plan (HDHP) in order to establish an HSA.
  • Withdrawals from an HSA can be made on a tax-free basis as long as they are used to pay for qualified medical expenses.
  • Unlike many employer-sponsored savings plans, an HSA allows you to roll over any money that you do not spend by Dec. 31.

1. Who Can Establish an HSA?

Employees of an employer-sponsored plan can often select an HSA from a menu of options. Anyone who is self-employed can also select this type of plan. However, it is important to understand that whether you are an employee or self-employed, you must be covered by a high-deductible health plan (HDHP) in order to establish an HSA. An HDHP is a medical insurance plan that has a higher-than-average specified minimum deductible. In 2021 and 2022, the HDHP minimum deductible for an individual is $1,400 and $2,800 for a family.

2. To Whom Is an HSA Most Appealing?

It seems that an HSA would be most appealing to an individual or family that has relatively modest medical care expenses, can afford a high-deductible medical plan, and could take advantage of the substantial tax benefits of a health savings account. It is important for each employee to compare an HSA to other medical plan options. 

3. Annual Contribution Limits

The annual contribution limits for HSA contributions in 2021 are $3,600 (individual) and $7,200 (family). In 2022, these limits increase to $3,650 and $7,300, respectively.

4. Catch-up Contributions

For individuals age 55 and older, additional catch-up contributions are allowed. For 2021 and 2022, this amount is $1,000. All contributions to an HSA must stop once the individual becomes eligible for Medicare.

5. Tax-Deductible Contributions

The most attractive feature of an HSA is the ability to make tax-deductible contributions that can earn a return. This is the first of three tax-related benefits for HSAs.

6. Earnings in the HSA Are Not Taxable

Another tax benefit is that you can avoid taxes on HSA investment gains. You could keep HSA funds in cash, but you may also have the opportunity to invest it in mutual funds or other securities. That can allow you to grow your savings more rapidly, and as an added bonus, those earnings are not considered taxable income.

7. Tax-Free Withdrawals

The third aspect of the triple tax savings offered by HSAs is that withdrawals can be made on a tax-free basis as long as they are used to pay for qualified medical expenses. If not used for medical expenses, withdrawals are taxable income.

8. Non-Qualified Withdrawal Penalties

If the owner of an HSA makes withdrawals prior to age 65 for non-medical expenses, an additional 20% tax penalty is imposed on the amount of the non-qualified withdrawal.

9. Use It or Lose It?

Unlike many employer-sponsored savings plans, an HSA allows you to roll over any money that you do not spend by Dec. 31. That means you can continue to accumulate savings in your account until you need it for healthcare expenses.

10. Approved Health Expenses

There are hundreds of IRS-approved health expenses and some health insurance deductibles and co-insurance are covered. For example, non-cosmetic dental treatments, crutches, hearing aids, laser eye surgery, contact lenses, eyeglasses, chiropractic care, acupuncture, and physical therapy are all covered by an HSA.

Note

The IRS issued a statement notifying taxpayers that at-home COVID-19 tests and personal protective equipment such as face masks and hand sanitizer are both considered eligible medical expenses that can be paid or reimbursed under health flexible spending arrangements (health FSAs), health savings accounts (HSAs), and health reimbursement arrangements (HRAs).

Are There Any Downsides?

Despite the lengthy list of benefits, HSAs do have some potential drawbacks. The biggest is that if you're not enrolled in a high-deductible health plan, you won't have access to an HSA. Even if you are enrolled in a high-deductible health plan, that can still be problematic for making HSA contributions. While your premiums may be lower each month, you'll still need to have more cash available to meet your deductible if you get sick or injured and need medical care. The money you may intend to save in your account may be needed to meet your deductible instead. Alternatively, you may prefer to earmark any available money that you have for an emergency fund to cover unexpected expenses.

Is an HSA right for you? The jury may be out, depending on your healthcare status and the size of your emergency savings fund. If you can afford a high-deductible healthcare plan, an HSA will provide you with the triple crown of tax savings which is a bonus in every taxpayer's pocket. Of course, it's always important to consider the cons as you weigh the pros to make sure it's the right savings choice for you.

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