Health Insurance Insurance

What is a Health Savings Account?

Written by Eric Rosenberg

The United States spends more on healthcare than nearly anything else. With an average of over $10,000 per person in 2016, healthcare is a hot topic in Washington and around the country.

President Trump has suggested health savings accounts as an alternative to Obamacare for Americans to handle their healthcare costs. Let’s take a look at what HSAs are, how they work, and if an HSA is right for you.

What is a health savings account?

A health savings account, or HSA, is a special savings and investment account designed to be used exclusively for healthcare related spending. Like a 401(k) or IRA, it has unique tax rules that can save you a ton of money compared to just paying for healthcare costs out of pocket from a regular bank account or credit card.

To qualify for an HSA, you must have a qualifying high deductible health plan, or HDHP, for your health insurance. IRS rules define HDHP insurance plans as any insurance policy with a deductible of $1,300 or higher for individuals or $2,600 for families.

How do health savings account taxes work?

In a regular investment or bank account, you pay taxes on your income and on any capital gains. With an HSA, you don’t pay any income taxes on cash you deposit and don’t have to pay any capital gains or other taxes when you withdraw. That is a better deal than you can get from a 401(k) or IRA!

The current limit you can save in an HSA is $3,400 for single individuals and $6,750 for families. If you contribute the entire $6,750 for a family and your top tax bracket is 28%, you would save $1,890 on your current year taxes. That is a huge savings!

When you contribute to an HSA, most account providers allow you to choose between keeping your funds in a regular savings account with minimal interest or investing in riskier investments for better returns. I have the bulk of my HSA balance in low-fee index funds like an S&P 500 index fund.

When you withdraw funds for any qualified medical expense, you do not pay any taxes on the withdrawal. Whether your cash just sat there earning bank interest or earned thousands from investments, withdrawals for medical purposes are tax free. If you withdraw for any other reason, the withdrawal requires paying taxes and penalties.

Secret health savings account retirement tricks

If you are sold on the benefits of an HSA, you are in good company. Millions of Americans are taking advantage of the great benefits from this type of investment, but your HSA can be used for better purposes than paying for doctor’s appointments and prescriptions this year. Some super savers are using their HSA as a form of retirement savings.

You can contribute up to $6,750 per year (as a family) into an HSA, that is more than the $5,500 limit with traditional and Roth IRA accounts. But unlike an IRA that can be cashed out penalty free during retirement, your HSA balance has to be used for medical expenses. That is not retirement savings on the surface, but with healthcare costs rising to around $100,000 for retirees, the value of an HSA in retirement becomes more clear.

Additionally, you can reimburse yourself for healthcare spending at any point after the spending took place. If you are meticulous with your record keeping, any dollar that you spend on qualified medical purchases can be withdrawn fee and penalty free at any time in the future.

If you maximize your contributions over a number of decades and track your medical spending over the same period, you can make a giant withdrawal during retirement up to that amount. And because you already paid the medical expense out of pocket, you can use those HSA dollars you withdrew for housing, food, or anything else.

This use for an HSA is not as common and can be quite complicated, so consider working with a financial advisor or accountant if you are worried about making an error along the way.

Is a health savings account right for you?

Health savings accounts are one of the most powerful tools you have to save money on healthcare and possibly for retirement. Saving and spending tax free for medical expenses can save you many thousands of dollars over time. That said, they are not perfect for everyone. Here are some things to consider before opening an HSA (see the next page):

  • Your insurance plan – To qualify for an HSA, you must have a high deductible health plan. That requires a minimum annual deductible of $1,300 or higher for individuals or $2,600 for families.
  • Your savings ability – To make a health savings account work, you have to contribute to it each year. Most employers that offer an HSA option as a benefit allow for automatic payroll deductions for your contributions. You can also setup your own automatic contribution or make lump deposits manually. If you have a lot of debt other than a mortgage, you should probably focus on paying that off before contributing heavily in an HSA.
  • Your healthcare needs – If you want to use your HSA as a pay-as-you-go tax saving vehicle for healthcare spending, make sure to save enough each year to cover any medical expenses you may incur. If you want to use it for a longer-term savings vehicle for retirement, your current healthcare spending is a less important factor.
  • Where to open an HSA

    If you are sold on a health savings account and want to get started, you have several options to open one. Some insurance companies, like United Healthcare, offer their own HSA option. Other insurers do not specify a preferred HSA vendor, so you can open one through any bank that offers HSA accounts.

    Most HSAs require paying a monthly fee unless you meet a minimum balance and each account provider offers different investment options and related fees, so research a few options before narrowing it down to your final choice.

    If you are stuck and work for a large company, reach out to your company’s HR department for suggested providers compatible with your current health plan.

    Are HSAs the next big thing in health insurance?

    President Trump wants to get rid of the Affordable Care Act, which could strip away health insurance from 20 million Americans, my family included. He suggested that health savings accounts could be part of a replacement. But, now that you know how HSAs work, you know that they are not a form of insurance. They are just a special savings and investment account used to save for healthcare costs.

    It would be great to see use of HSAs increase as more Americans learn about the tax saving benefits, but forcing everyone into high deductible plans with an HSA would be counterproductive for the healthcare needs of millions of people.

    No one knows what the future holds, but one thing is for sure. HSA accounts are an option today, and offer a lucrative opportunity to save on taxes while stashing money away for healthcare and your future. If you qualify for an HSA, there is no reason to delay!

    About the author

    Eric Rosenberg

    Eric Rosenberg is a finance, travel, and technology writer originally from Denver, Colorado living in Ventura, California. When away from the keyboard, Eric he enjoys exploring the world, flying small airplanes, discovering new craft beers, and spending time with his wife and baby girl. You can connect with him at his own finance blog Personal Profitability.

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