Health Savings Accounts: A Best-Kept Secret?

In many of my own client interactions, I find that people may have a decent understanding of an HSA, but they may not fully be aware of all the advantages that go along with using one.

A Health Savings Account is a tax-advantaged account designed to allow HSA owners to save toward future healthcare-related expenses that may not be covered or reimbursed under their high-deductible health insurance plan. As with most tax-advantaged accounts, HSAs also come with a few restrictions (discussed below).

Tax Advantages of a Health Savings Account

There are three main tax benefits of using a Health Savings Account. First, when money is contributed, it goes into the HSA on a pre-tax/tax-deductible basis, which is similar to IRA or 401k contributions (see this post for more on these and other tax-advantaged accounts). This results in the lowering of your taxable income for the year you make the contribution, which lowers your income taxes.

Next, the money that is inside a Health Savings Account can grow year after year on a tax-free basis (similar to a Roth IRA). In other words, you can avoid taxes as your HSA (hopefully) grows over time.

Lastly, qualified withdrawals can be taken from an HSA on a tax-free basis as well. Qualified withdrawals are withdrawals used for qualified medical and dental expenses. You can learn more about what exactly consists of a qualified expense by reviewing IRS Publication 969 or IRS Publication 502. Another great benefit of an HSA is that you can withdraw contributions and earnings at any time, unlike IRAs, which require you to be 59 1/2 before withdrawing (certain exceptions apply).

Unlike other tax-advantaged accounts (IRAs, Roth IRAs, etc.), HSAs are extremely unique in that they allow tax advantages in all three different ways mentioned above (pre-tax contributions, tax-free growth, and tax-free withdrawals), as long as those withdrawals are used for medical expenses.

What if I need the money for reasons other than healthcare expenses?

Everything about HSAs so far sounds great, but what if you need to withdraw money from your HSA for reasons other than for qualified medical expenses? The answer is that you would have to pay income tax plus an additional tax of 20% on the portion of the distribution not used for qualified medical expenses, which is a steep price to pay.

However, there are exceptions to this rule. If you take distributions after you reach age 65, become disabled, or die, there is no additional 20% penalty on distributions. Therefore, if you are 65 or older, your Health Savings Account can almost serve as an additional IRA for you at that time, as withdrawals would trigger income tax, but no additional penalty.

Can I use a Health Savings Account?

One drawback to HSAs is that they must be used in conjunction with a high-deductible health insurance plan. What does “high-deductible” mean exactly? For 2022, the minimum “self-only” deductible is $1,400 for an individual and $2,800 for a family.

What are the contribution limits for Health Savings Accounts?

For someone on a high-deductible health plan that has “self-only” coverage, the contribution limit for an HSA is $3,650 in 2022 ($7,300 for those with family coverage). But, HSAs also have a catch-up provision that allows individuals 55 and older to contribute up to $1,000 more to their account per year. Therefore, a couple both over the age of 55 (and on a high-deductible health insurance plan in 2022), could contribute up to $8,300 to the primary HSA owner’s account, plus another $1,000 to the spouse’s HSA (must be in a separate HSA).

Investment options

While everyone who contributes to and takes qualified withdrawals from an HSA will receive tax benefits, not everyone takes full advantage of the potential for tax-free growth through investing. One reason is that not all HSAs allow for investing in mutual funds, but some do.

To see if your HSA offers investment options, you can contact your provider or login to your account. If investment options are not offered, it is possibly that you could transfer your HSA to a different provider that does offer investment options. However, it’s important that you invest appropriately and according to the timeframe that you may need to access the funds in your HSA.

If you are not currently using an HSA but are eligible to start, it’s important to evaluate the different features of each plan provider. You should weigh the fees of each plan, and of course, make sure that the plan offers investment options that you can take advantage of for the long-term. (You can click here for a list of HSA providers and a comparison of their benefits)

Record-keeping and reporting

As with anything that deals with the IRS, it’s good to keep accurate records regarding your HSA. As stated in Publication 969, you must have records to show that your distributions were used to pay or reimburse qualified medical expenses. Those expenses also cannot have been previously paid or reimbursed from another source or taken as an itemized deduction in any year.

There are also nuances in how you report HSA distributions on your tax return. It’s important to speak with a qualified tax professional to ensure you are properly reporting your distributions.

What about FSAs?

FSAs, or Flexible Spending Accounts, provide an alternative to HSAs for a medical expense savings account. In fact, the two are often confused with one another. One of the few pros for FSAs is that anyone with a traditional health plan is eligible to participate.

However, there are many reasons why an FSA is quite inferior to an HSA; contribution limits are lower than for HSAs, there are no investment options offered, you can only carry-over a maximum of $570 (in 2022) of any unused balance year-to-year (you can always carry over your HSA balance from year-to-year), there is no catch-up provision, FSAs are not portable to another employer, and changes to contributions can only be made at a qualifying event such as a marriage, divorce, birth, or during open enrollment.

Bottom Line

It’s clear to see why a Health Savings Account could be such an attractive option for those who qualify to use one. It’s not clear why these types of accounts do not seem to be emphasized or talked about as much as IRAs, 401(k)s, etc. But, now that you’re educated about HSAs, speak with a qualified investment adviser or a CERTIFIED FINANCIAL PLANNER™ professional to see if a Health Savings Account is a prudent option for you.

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