For many people, healthcare is one of the largest necessary expenses every year. There are all sorts of health insurance plans ranging from low premium plans with high deductibles to high premium plans with low deductibles. Regardless of which type of health insurance you have, unexpected medical events can be costly and interfere with your other financial plans.
To encourage people to save for some of these unexpected medical expenses, the government created the HSA or Health Savings Account.
What is an HSA?
A Health Savings Account is essentially a savings account dedicated for medical expenses. Typically, these plans are started through your employer or a financial institution. Both the employee and the employer have the ability to add to the account. As an incentive to add to these accounts, there are some major tax benefits. Contributions are tax deductible, growth is tax free, and distributions are tax and penalty free if taken out for qualified medical expenses.
Qualified medical expenses include deductibles, dental care, vision care, prescription drugs, psychiatric treatment, copays and more. In general, health insurance premiums do not count as qualified expenses except for Medicare premiums, COBRA coverage premiums, and long term care insurance premiums.
Who is eligible for an HSA?
In order to start up an HSA, you must be under 65, must not be claimed as a dependent, and must have a High Deductible Health Plan (HDHP). An HDHP is a health insurance plan with a large deductible for medical expenses, meaning that medical care would require a relatively high amount of out-of-pocket expenses. Because of this, HDHPs usually have relatively low monthly premiums. For 2021 and 2022, the IRS defines an HDHP by having a deductible that is at least $1,400 for individuals and $2,800 for families. Your employer may offer an HSA or you can start up an account at your bank or other financial institution.
5 Advantages of an HSA
- Tax Advantages – If utilized correctly, there can be some huge tax benefits for HSAs. Contributions are tax deductible, whether made by the employer or the employee, so they can save you money on taxes in the current year. Growth is tax free, and withdrawals are 100% tax and penalty free if used for qualified medical expenses. That is a triple tax savings! You’re saving today, while the money is in the account, and when you take the money out. Not many vehicles in finance allow for this treatment.
- Unused balances are rolled over indefinitely – If you don’t withdraw your balance by the end of the year, not to worry! You can rollover your balance to the next year indefinitely.
- Portability – You can take your HSA with you if you leave an employer.
- Potential for growth – Many HSA plans allow your money to work for you while in the account. Some provide an interest rate, while other HSA plans will allow you to choose an investment portfolio to grow your money. The great thing is that this growth isn’t taxed!
- Savings for unexpected medical expenses – Saving into an HSA plan promotes good savings habits and helps you be prepared for unexpected medical expenses that could otherwise put you into financial difficulty.
Drawbacks of an HSA
- Contribution Limits – In 2021 the annual contribution limit is $3,600 for individuals and $7,200 for families. In 2022, the annual contributions limits will rise to $3,650 for individuals and $7,300 for families.
- Penalties for incorrect usage – There are some steep penalties if your HSA is not used correctly. First, there is a penalty if you contribute too much into your HSA. If you overcontribute, you pay a 6% penalty, and your contributions are not tax deductible. There is also a penalty if you pull money out for non-medical expenses. If you are under 65 and you pull money out for non-medical expenses, you will pay a 20% penalty and you will have to pay taxes. If you are over 65, you won’t pay the 20% penalty but taxes will still be due.
- Budgeting constraints – In order to be useful, you must actually add to your HSA. If you have significant budget constraints and can’t add to the HSA as planned, you could find yourself in a tough spot if you have an unexpected medical event, especially considering your High Deductible Health Plan.
Conclusion
Overall, if you are eligible for an HSA, they can be an advantageous addition to your overall financial plan. They provide solid tax advantages and can help you when you need money the most. Due to some of the limits and penalties associated with them, however, we recommend consulting your financial advisor and/or tax advisor to make sure that you are utilizing your HSA for your maximum benefit. If you have questions or need to review your HSA, contact one of our advisors today.