Health savings accounts, or HSAs for short, are a type of checking account that you can utilize if you have a high-deductible health plan. They allow you to put aside money on a tax exempt basis to pay for qualified medical expenses. Consider your HSA to act much as a personal checking account does. The only difference is that the funds in this account may only be used to pay for qualified, health-related services. HSAs are different from Flexible Spending Accounts (FSAs) in that they do not expire at the end of the year and your contributions to the account can roll over from one year to the next.
The better you understand your HSA, the better prepared you will be to make it work for you. Because the funds can roll over from year to year, you can consider it an investment in your future health – to help cover the costs of care as you age if you never need to use all the funds in your account.
It’s important to understand how the funds can be used to help you get appropriate treatment and care. For instance, your health savings account can be used to do any or all of the following:
- Pay medical deductibles.
- Purchase prescription medication.
- Pay for dental visits and services.
- Pay for vision visits and services.
- Cover the medical services and equipment expenses.
- Reimburse yourself for medical expenses not covered by insurance that you paid out of pocket.
- Cover chiropractic services costs.
- Pay for psychological counseling.
- Cover physical, occupational, or speech therapies expenses.
The rules on HSA use have gotten stricter in recent years. For example, HSA funds are no longer acceptable, for things like over-the-counter medications without a prescription.
Other items ineligible for HSA spending include:
- Nutritional supplements
- Weight loss programs (unless prescribed by your physician to treat a specific covered medical condition)
- Health club memberships
- Insurance premiums
- Hair transplants
- Hair removal
- Cosmetic surgeries
These are just the highlights. Make sure you go over the list of eligible and ineligible expenses, so you don’t find yourself paying taxes or penalties on health savings account funds.
Benefits of HSAs
The benefits of health savings accounts are significant. The first benefit is that the money contributed to the HSA can be done on a pre-tax basis. That means funds can be deducted from your pay check and sent directly to your HSA, which lowers your taxable wages. Additionally, you can fund your HSA through after tax contributions (contributions made outside of payroll) and then deduct this when filing your annual income taxes. The only downside to this is that you will miss out on the full pre-tax benefit. Claiming this on your taxes will lower your Federal and State taxable liability, but will not lower your payroll tax liability (OASDI and Medicare for a combined 7.65%). While this is a great benefit, there are limits as to how much money you can contribute to your fund each year. Interest earned on HSA balances is also tax-free.
The other benefit you’ll want to keep in mind involves employer contributions. No matter how much, or how little, your employer contributes, you should view this as a great benefit to saving for you and your family's current or future health and medical care. This employer contribution does count toward your annual contribution limit, so please keep this in mind when deciding how much you should contribute yourself.
The most significant benefit, though, is that the money continues to build up in your account until you spend it. From year to year, you keep adding to your health savings account until you have medical/dental/vision expenses that require you to spend the money. Further, your HSA is portable. That means it remains with you, whether you change your employer or leave the workforce entirely.
Risks of HSAs
One of the risks of an HSA is that while it is your money, you will only receive the tax-free benefit if the funds are used for a qualifying expense. Unqualified withdrawals may have you paying up to 20 percent in penalties for the money, plus paying taxes on the money you spent.
If the money remains in your account until you reach the age of 65, the money is then treated as a standard retirement plan and taxed upon withdrawal. That means you lose the tax benefit. However, at this point, you are no longer subject to early or non-qualified withdrawal penalties.
Also, be aware that some health savings accounts charge monthly maintenance fees, so choose your plan wisely. HSAs are not for everyone, but in many situations, they can prove critical in helping shield families from the financial repercussions medical expenses can create. Compare your options to see if this is the right choice for you.
You can learn more about HSAs by reading the IRS Publication 969 Health Savings Accounts and Other Tax-Favored Health Plans.