An HSA also known as a Health Savings Account, can help cover medical expenses given that you are eligible to open it. Keep on reading to find out more.
What is HSA? A Health Savings Account, or HSA, is a practical way to save for medical costs and lower your taxable income. However, not everyone can — or should — enroll for the kind of health insurance plan needed to open an HSA. Continue reading to learn more about what HSA is, how they work and how they can benefit you.
Table of Contents
- 1 What is an HSA account and how does it work?
- 2 What is a high-deductible health plan and how does it work?
- 3 HSA eligibility
- 4 How much cash can I deposit annually into an HSA?
- 5 HSA pros and cons
- 5.1 Advantages of Health Savings Accounts
- 5.2 Disadvantages of Health Savings Accounts
- 6 HSA tax benefits
- 7 Withdrawals allowed under an HSA
- 8 HSA contribution guidelines
- 9 Tax differences between HSAs vs. FSAs
- 10 Important things to considerations
- 11 Conclusion
What is an HSA account and how does it work?
A Health Savings Account (HSA) is a tax-advantaged savings account that is made for individuals who get their insurance inclusion through high-deductible health plans (HDHPs). Standard contributions to the account are made by the employee or employer and can be utilized to pay for qualified medical costs that are not covered by the HDHPs. The contributions, which have a yearly cap, can be utilized to pay for medical, dental, and vision care just as prescription medications.
Also, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, sanctioned in 2020 because of the COVID-19 pandemic, permits HSA assets to be utilized for over-the-counter drugs without a prescription and some other health-related items. Plan holders who are uncertain about which costs qualify can check with their employer’s HSA administrator or a pharmacist.
The vast majority who have high-deductible medical insurance plans have the alternative of adding a HSA. The two are generally matched together. For qualifying for HSA, a person should:
- Have a qualified HDHP
- Have no other health coverage
- Not be claimed as a dependent on someone else’s tax return
- Not be enrolled in Medicare
The maximum contribution for an HSA is $3,600 for an individual and $7,200 for a family as of 2021. Individuals 55 years old or more before the end of the tax year, can make catch-up to contributions of an extra $1,000. The yearly limits on contributions apply to the total dollars contributed by both the employer and the employee.
The 2021 HSA commitment limits are $3,600 for an individual account and $7,200 for a family account for people younger than 55. Qualified individuals who purchase their insurance all alone can open a HSA at certain monetary situations. Commitments by the individuals who get employer-supported health insurance pay for their HSAs through payroll deductions.
Some other individual, like a relative, can likewise add to the HSA of a qualified person. Self-employed or jobless people might add to an HSA in the event that they meet the qualification necessities. People who take on Medicare cannot contribute to an HSA anymore as of the first month of enrollment. In any case, they can get without tax conveyances for qualified medical costs.
A few employers that offer high-deductible health plans additionally offer HSAs. In the event that yours does not, you can open a separate HSA account as long as you have an eligible plan. Every year, you choose the amount to add to your HSA account, however you cannot surpass government-mandated maximums. On the off chance that you have an HSA through your workplace, you can set up simple automatic contributions directly from payroll.
You will get a debit card or checks connected to your HSA balance, and you can utilize the assets on qualified medical costs. This incorporates deductibles, copays and coinsurance, in addition to other qualified medical costs not covered by your plan. Know that insurance expenses typically cannot be paid for with HSA funds.
As compared to a Flexible Spending Account, your HSA balance turns over from one year to another, so you never need to stress over losing your savings. When you are over 65 years old and enrolled in Medicare, you cannot contribute to an HSA anymore, however you can in any case utilize the cash for out-of-pocket medical costs. In the event that you utilize the cash on non-qualified costs, you need to pay annual tax on that sum (in addition to a penalty in case you are under 65).
What is a high-deductible health plan and how does it work?
As its name suggests, it is a health insurance plan that has a high deductible. A deductible is the amount of medical costs you should pay every year before coverage kicks in. High-deductible plans do not start paying until after you have spent at least $1,400 (for an individual) or $2,800 (for a family) of your own cash on health care costs, in spite of the fact that deductibles fluctuate from plan to plan.
The maximum deductible is $7,000 for an individual or $14,000 for a family. While the deductible is high with this sort of plan, the premium (the customary expense you pay to get coverage) is normally lower than that for conventional plans. Additionally, numerous preventive administrations, like mammograms, are covered before a deductible is met. You can use your HSA to pay deductible costs, along with copays and some other health care expenses that are determined by the individual HSA.
High-deductible health plans are turning out to be progressively common. Organizations are bound to offer them as their only plans or as one of the limited choices they give. It is fundamentally important to carefully review the plan’s coverage details, including the out-of-pocket maximum — the limit on the amount you would need to pay for medical costs in a year.
There are three things that need to be true in order for you to open an HSA:
- You are enrolled in an HDHP. (In 2020, that meant that your health insurance plan had a minimum deductible of $1,400 for single coverage or $2,800 for family. It also meant a maximum annual out-of-pocket cost of $6,900 for individuals and $13,800 for families; including things like deductibles, copayments and coinsurance — but not your premium.
- You are not enrolled in Medicare.)
- You are 18 years old or more and no one can claim you as a dependent on their tax return.
Moreover, setting up an HSA account is extremely simple. You can literally do it in five minutes. And if you are enrolled in an HDHP, it is a no-brainer.
How much cash can I deposit annually into an HSA?
The contribution limits for HSAs are set by the Internal Revenue Service. In recent years, the limits have been $3,600 for individuals and $7,200 for family coverage. As soon as you are enrolled in Medicare, you cannot continue making contributions to your HSA. However, in the years leading up to retirement — between the ages of 55 and 65 — you can make “catch-up” contributions of up to $1,000 over the limits to assist in paying for medical expenses in retirement.
HSA pros and cons
Advantages of Health Savings Accounts
The following list mentions the advantages of Health Savings Accounts.
Many Expenses Qualify
Qualifying costs include a vast range of medical, dental, and mental health services. They are explained in detail in IRS Publication 502, Medical and Dental Expenses.
Others Can Contribute
Contributions can come from you, your employer, a relative, or anyone who wants to add to your HSA. However, the IRS does set limits. For 2021, the limit is $3,600 for a single individual and $7,200 for families ($3,550 and $7,100, respectively, for 2020). Moreover, an additional $1,000 “catch-up” contribution is required for anyone who is 55 years old or more by the end of the tax year.
Contributions are usually made with pretax dollars through payroll deductions at your employer. Consequently, they are not included in your gross income and are not liable to federal income taxes. In most states, contributions are not liable to state income taxes.
Tax-Deductible After-Tax Contributions
If you make contributions with after-tax dollars, you can subtract them from your gross income on your tax return, lowering your tax bill for the year. For instance, if you are an individual under 55 years old, your maximum permitted contribution in 2021 is $3,600 ($3,550 for 2020). If you only deposit $2,600 into your HSA through payroll deductions by the end of the year, you may decide to deposit an extra $1,000 to lower your tax liability. You usually have until the respective IRS tax filing deadline to contribute.
Withdrawals from your HSA are not liable to federal (or often, state) taxes if you use them for qualified medical costs. However, HSAs can be used as investment accounts, permitting you to buy stocks and other securities to potentially increase your returns. Investing in stocks comes with the risk of loss of principal, and should only be considered as part of a diverse, long-term wealth-building strategy. It would be smart to seek the advice of a financial planning professional before taking any such steps.
Any interest or other earnings on the cash in the account is tax-free. Most HSA accounts earn a minimal amount of interest, less than 0.1%.
In case you have cash left in your HSA by the end of the year, it rolls over to the next year. This offers more adaptability than Flexible Spending Accounts (FSAs), which usually can only be carried over in a sum up to $550 or 2.5 months into the following plan year.
The cash in your HSA remains accessible for future eligible medical costs even if you change health insurance plans, go to work for a different employer, or retire. Fundamentally, your HSA is a bank account in your name, where you choose how and when to use the funds.
Most HSAs issue a debit card, so you can immediately pay for prescription medicines and other qualifying costs. If you wait for a medical bill to come in the mail, you can call the billing center and make a payment via phone using your HSA debit card. You can also reimburse yourself out of an HSA if you have paid a medical bill with an alternative form of payment.
Disadvantages of Health Savings Accounts
If you are eligible for an HSA, here are some of the disadvantages to keep in mind:
A High-Deductible Health Plan, which you need to have to be eligible for an HSA, can put a greater financial weight on you than other kinds of health insurance. Even though you will pay less in premiums each month, it could be hard — even with money in an HSA — to come up with the money to meet the deductible for an expensive medical procedure. This is something to consider for anyone who knows they will have heavy medical bills in a particular plan year.
Pressure to Save
Some people may be hesitant to seek healthcare when they need it because they do not want to spend the money in their HSA account.
Taxes and Penalties
If you withdraw funds for non-qualified costs before you turn 65 years old, you will owe income taxes on the money plus a 20% penalty. After the age of 65, you will owe taxes but not the penalty.
You need to keep receipts to prove that your withdrawals were used for eligible health costs. This will be important if you are audited by the IRS.
Some HSAs ask for a monthly maintenance fee or a per-transaction fee, which changes from one institution to another. While it is usually not very high, the fees are almost certainly higher than any interest the account may earn and do cut into your bottom line. Often these fees are waived if you maintain a specific minimum balance.
HSA tax benefits
If you want to take advantage of this tax-advantaged savings account, you must add some cash to the pot. However, before you withdraw a gigantic load of cash from the bank, know that there are limits to the amount you can add to your HSA.
In 2020, the maximum yearly HSA commitment you can make as an individual is $3,550. For families, that number goes up to $7,100. In case you are 55 years old or more (and not enrolled in Medicare), you can likewise make a yearly “catch-up contribution” of $1,000.
In any case, remember, these numbers incorporate employer contributions. You would prefer not to surpass these limits, or you will get hit with a 6% tax. Regardless of whether you contribute $50 or $7,100, here are the three significant tax benefits you will appreciate with an HSA:
Perhaps the best advantage of an HSA is that when you make a contribution, you are adding cash tax-free. That can occur two or three different ways. The first is through a pretax payroll deduction. This implies that your employer drops whatever HSA funds you have reserved to emerge from your paycheck straight into your HSA account. That cash goes into your HSA and is not considered as income. Therefore, it cannot be taxed.
Be that as it may, it could be possible that you do not get your insurance through your employer, or your employer does not route assets for your sake to your HSA. You do not need to worry about it. Make your contributions as you normally would, and afterward come tax time, claim those contributions as tax deductions so they are not considered to be income.
If you are self-employed, you contribute pretax and it will not be counted toward your taxable income. People in New Jersey and California will have to pay state income tax on their HSA contributions.
Since your cash is living it up in an HSA, here comes the second tax-free bonus: Your cash grows without tax. Keep in mind, an HSA is a health savings account, so it behaves like a savings account and acquires interest. Yet, unlike a normal savings account where premium acquired will be considered taxable pay, your HSA contributions can grow without the tax hit. However, in New Jersey and California, any HSA profit is viewed as taxable pay.
With an HSA, not exclusively are you saving cash for current medical costs but on the other hand you are ready to save up for future health care costs. Regardless of whether it is this year or 10 years from now, when the opportunity arrives to create a withdrawal you can take that cash out tax-free as long as it is intended for a qualified medical cost. There is another per-within-a-perk here as well. When you turn 65 years old, your HSA will likewise behave like a customary IRA. You can pull out assets from your HSA for anything that you would like, not simply qualified medical costs. Remember however that you will pay taxes on those subsidies when you do. Whenever you are enrolled in Medicare, you will not have the option to add to your HSA any more. However, simply think, all of the contributions you made pre-Medicare will give you the opportunity to pay for medical costs in retirement from your HSA, all without tax!
In short, the three tax benefits are as follows:
- Contributions to HSAs are not subject to federal income taxes.
- Earnings to an HSA from interest and investments are tax-free.
- Distributions from an HSA to pay for qualified medical expenses are tax-free.
Withdrawals allowed under an HSA
Amounts withdrawn from an HSA are not taxed as long as they are utilized to cover services that the IRS treats as qualified medical costs. Here are some of the basics:
- Qualified medical expenses incorporate deductibles, dental services, vision care, prescription drugs, copays, psychiatric treatments, and some other qualified medical costs that are not covered by a health insurance plan. Note that this list was expanded by the CARES Act.
- Insurance premiums do not count towards a qualified medical expense unless the premiums are for Medicare or other health care coverage (given that you are 65 years of age or older); for health insurance when getting health care continuation coverage (COBRA); for inclusion when getting unemployment compensation, or for long-term care insurance, liable to yearly adjusted limits. Premiums for Medicare supplemental or Medigap policies are not qualified medical costs.
If distributions are made from an HSA to pay for anything other than a qualified medical cost, that sum is liable to both income tax and an extra 20% tax penalty.
HSA contribution guidelines
Contributions made to a HSA do not need to be utilized or removed during the tax year. They are vested and any unused contributions can be turned over to the next year. Additionally, an HSA is convenient, implying that if employees change jobs, they can keep their HSAs. An HSA plan can be moved to a surviving spouse tax-free upon the passing of the account holder. In any case, if the assigned recipient is not the account holder’s spouse, the account never again is treated as an HSA and the recipient is taxed on the account’s fair market value, adapted to any qualified medical costs of the decedent paid from the account within a year of the date of death.
Tax differences between HSAs vs. FSAs
If you have heard of HSAs, then you might have also come across FSAs, or Flexible Spending Accounts. Both of them are like emergency funds for medical costs, but how they function out in the real world is quite different. Let us take a closer look at their tax differences.
FSA annual contribution limits are lower.
In 2020, you could contribute up to $2,750 into an FSA. Since FSAs are only available through employers, your employer could also set the limit lower than $2,750. However, with an HSA, an individual can contribute up to $3,550 or $7,100 for a family. The nearer you get to those maximum contributions, the less you have to report as taxable income.
HSA funds roll over, but FSA funds do not.
HSAs definitely have an advantage over FSAs here. FSAs are “use it or lose it,” so any funds you did not use in a calendar year are lost. (You might be able to rollover $500 if your employer provides you with that choice, but that is the maximum.) You might be wondering what that has to do with your taxes? Well, since HSA funds roll over, you can proceed to grow your account year over year. All those contributions are going in tax-free and growing tax-free. An FSA zeroes out each year with no opportunity to earn tax-free interest.
You cannot invest your FSA funds.
One of the lesser known advantages of an HSA is that you can invest those funds into good growth stock mutual funds. Since FSA funds have a year-long lifespan, you lose the investment opportunity — and the tax benefits — with an FSA. Without the investment piece, opting for an FSA means losing out on tax-free interest and earnings.
Important things to considerations
HDHPs have higher yearly deductibles yet lower premiums than other health plans. That is, the month to month costs are lower but the individuals covered are answerable for their own medical expenses up to a set amount. The monetary advantage of a HDHP’s low-premium and high deductible construction relies upon your own circumstance.
The minimum deductible needed to open an HSA is $1,400 for an individual or $2,800 for a family for the 2021 tax year. The plan should likewise have a yearly out-of-pocket maximum of $7,000 for self-coverage and $14,000 for families for the 2021 tax year. These maximums cap your out-of-pocket costs.
At the point when an individual pays qualified medical costs equivalent to a plan’s deductible sum, extra qualified costs are split between the individual and the plan. For example, the insurer covers a percentage of the qualified costs according to the agreement (generally 80% to 90%) while the plan holder pays the leftover 10% to 20% or a predefined copay.
For instance, using this guide, a person with a yearly deductible of $1,500 and a medical claim of $3,500 pays the first $1,500 to cover the yearly deductible. The insured pays 10% to 20% of the remaining $2000 while the insurance company covers the remaining.
When the annual deductible is met in a given plan year, any additional medical costs are usually covered by the plan with the exception of any uncovered costs under the contract, such as copays. An insured can withdraw money accumulated in an HSA to cover these out-of-pocket costs.
In case you are enrolled in a high-deductible health plan, the tax benefits of an HSA and the capacity to turn over unspent cash are appealing. In any case, high-deductible health plans are not usually the most ideal choice, particularly in the event that your expected healthcare costs are high. With everything taken into account, HSAs are a standout amongst other tax-advantaged savings and investment tools accessible under the U.S. tax code. They are often alluded to as triple tax-advantaged in light of the fact that contributions are not liable to tax, the cash can be invested and grow without tax, and withdrawals are not taxed as long as they are utilized for qualified medical costs. As an individual ages, medical costs will in general increment. Starting an HSA at an early age, if you qualify, and permitting it to amass throughout an extensive stretch of time, can contribute extraordinarily to getting you your financial future.