What is a Health Savings Account (HSA)?
The Health Savings Account (HSA) is tax-advantaged for individuals with a high-deductible health plan (HDHP) to save for eligible medical costs. Individuals or employers can contribute up to a certain amount every year. Time-invested contributions can cover eligible medical expenditures, including medical, dental, vision, and prescription medicines.
How HSAs Work
As noted, HDHP holders can open HSAs. Pairing HDHPs and HSAs is common. To get an HSA, taxpayers must fulfill IRS qualifying conditions. An eligible person:
- Qualified HDHP
- No other health insurance
- Not enrolled in Medicare.
- Not declared as a dependant on another’s tax return
The maximum HSA contribution in 2022 is $3,650 for individuals ($3,850 for 2023) and $7,300 for families ($7,750 for 2023). The yearly contribution restrictions apply to employer and employee contributions. HSA catch-up payments of $1,000 are available to individuals 55 or older at the end of the tax year.
Some financial institutions provide HSAs. Contributions are cash-only, whereas employer-sponsored plans rely on employee and employer funding. Anyone, including family members, can contribute to a qualified HSA. Self-employed or jobless people can contribute to an HSA if they fulfill qualifying conditions.
Medicare enrollees cannot contribute to an HSA after the first month of enrollment. If they have eligible medical costs, they can get tax-free payouts.
The CARES Act of 2020 authorized HSA funding for non-prescription over-the-counter drugs and other health items. Ask your HSA administrator or pharmacist what costs qualify.
Special HSA Considerations
High-deductible health plans (HDHPs) feature larger yearly deductibles but cheaper premiums than other plans.HDHP’s cheap premium and high deductible structure may assist you financially.
The minimum deductible to start an HSA in 2022 is $1,400 for individuals and $2,800 for families ($1,500 and $3,000 for 2023). In 2022, the plan must offer an annual out-of-pocket limit of $7,050 for self-coverage ($7,500 for 2023) and $14,100 for families ($15,000 for 2023). These maximums limit out-of-pocket costs.
The plan and individual split further eligible medical expenditures once an individual pays the deductible. The insurer pays 80% to 90% of approved expenditures per contract, while the plan bearer pays 10% to 20% or a co-pay.
In 2023, a person with a $1,500 yearly deductible and a $3,500 medical claim will pay the first $1,500 using this approach. The insured pays 10% to 20% of the remaining $2,000, while the insurer pays the remainder.
After meeting the yearly deductible, the plan usually covers all further medical expenses except for contract-covered items like co-pays. Insured individuals can use HSA funds for out-of-pocket expenditures.
HSAs differ from health spending accounts, which Canadian companies utilize to provide health and dental benefits.
Health Savings Account (HSA) Pros and Cons
There are pros and cons to using HSAs. Personal and financial circumstances determine the impact of these accounts.
Advantages
Employees’ taxable income excludes company and individual HSA payments made through payroll deductions. Employees can deduct 100% of their direct HSA payments from their income. Account earnings are tax-free. A 6% tax applies to excess HSA contributions, which are not tax deductible.
The IRS defines HSA distributions as tax-free if they are utilized for eligible medical costs. Distributions for HDHP-covered medical expenditures count against the deductible.
Investing in equities and securities with your HSA might yield more significant profits.
Disadvantages
The biggest issue is that you must qualify for an HDHP. You must also have a high-deductible plan, reduced insurance rates, or enough wealth to purchase them and enjoy tax benefits.
HSA funders, whether through payroll deductions or directly, should be able to save enough to cover a large percentage of their HDHP deductibles. The high deductible may be problematic for those without enough HSA funds.
HSAs involve contribution filing, withdrawal regulations, distribution reporting, and record-keeping, which can be challenging.
HSA-Allowed Withdrawals
If utilized for IRS-qualified medical costs, HSA withdrawals are tax-free. The plan manager will issue an IRS Form 1099-SA for HSA disbursements. Know these basics:
- Deductibles, dental, vision, prescription medicines, co-pays, psychiatric, and other expenditures not covered by a health insurance plan are qualifying medical expenses. The CARES Act enhanced these.
- Insurance premiums are not considered qualified medical expenses unless they are for Medicare, COBRA, unemployment compensation, or long-term care insurance, subject to annual limits. Medicare supplement and Medigap premiums are not eligible for medical costs.
HSA disbursements for non-qualified medical expenses are subject to income tax and a 20% tax penalty. For non-qualified withdrawals, only income tax applies after 65.
Health Savings Account (HSA) Contribution Rules
They are not using or withdrawing HSA contributions throughout the tax year. Vesting allows unused contributions to be carried over to the following year. HSAs are transferable, so employees may keep them when they switch employment.
A spouse can transfer an HSA plan tax-free when the account holder dies. Suppose the designated beneficiary is not the account holder’s spouse. In that case, the account is no longer considered an HSA, and the beneficiary is taxed on the account’s fair market value, adjusted for qualified medical expenses paid within a year of death.
Flexible spending vs. Health Savings Account (HSA)
Compare the HSA to the Flexible Spending Account (FSA). Both accounts can cover medical bills, but there are significant differences:
- Employers sponsor FSAs.
- Only employed people can get FSAs.
- The FSA forfeits unused cash after the tax year.
- FSA contributions are fixed, unlike HSA contributions.
- FSA contributions totaled $2,850 in 2022 ($3,050 in 2023).
Self-employed? Can I open an HSA?
Yes. HSAs are available to HDHP holders. Fidelity, HealthEquity, and Lively provide HSAs for self-employed people. Carefully research your alternatives to get the best HSA for your requirements.
Should I utilize all my HSA funds each year?
No. HSA donations roll over the year, unlike FSA contributions. Users can invest the cash for more extensive medical needs or retirement investments.
Can I use HSA funds for insurance?
Not usually. HSAs can cover doctor’s visits, prescriptions, and over-the-counter drugs, but not monthly premiums. The lone exemption is using unemployment compensation to pay Medicare premiums, or COBRA. You may use HSAs for long-term care insurance.
The Verdict
HSAs are a top tax-advantaged savings and investment instrument under the U.S. tax law. People call them triple tax-advantaged because:
- Contributions are tax-free.
- Invest and grow tax-free.
- Use withdrawals for eligible medical costs to avoid taxes.
Medical costs rise with age, especially after retirement. Thus, creating an HSA early if you qualify and letting it grow can help secure your financial future.
Conclusion
- HSAs are tax-advantaged accounts that enable individuals to save for medical expenditures not covered by high-deductible health plans (HDHPs).
- HSA contributions, profits, and payouts for eligible medical expenses are tax-free.
- Employers and employees can finance employee-owned HSAs.
- You can carry forward unused account balances at year-end and vested contributions.
