How they work
As the name implies, a high-deductible health plan won’t start covering your medical costs until you’ve paid a certain amount of them on your own that year, i.e. the deductible (between $1,400 and $7,000 for an individual, and between $2,800 and $14,000 for a family). A health savings account, or HSA, is used to set aside money to pay those deductibles. In 2021, individuals and their employers can contribute up to $3,600 to their account. Families can contribute up to $7,200. If you’re 55 or over, you can chip in an additional $1,000 as a catch-up contribution. While there can be limited restrictions, most individuals can contribute to an HSA as long as they are covered under a qualifying high-deductible health plan, are not claimed as a dependent on someone else’s tax return, and are not currently on Medicare.
Benefits of HSAs
Health savings accounts provide several significant benefits. First, there are several tax advantages. Contributions to HSAs are tax-deductible. In addition, the account grows tax-free and distributions from the HSA are not taxed, as long as the funds are used to pay eligible medical expenses. The HSA is the only savings vehicle that not only allows an upfront tax deduction, but also provides for tax-free distributions. Second, you are in complete control of how your HSA funds are spent, so you’re free to shop around for health care services based on quality, cost, or any other factor that’s important to you. Third, since it’s tied to a high-deductible health plan, your monthly premiums will likely be significantly lower than with other types of plans. Lastly, the money you contribute is yours indefinitely.
Of course, there are potential disadvantages as well, the most notable being that if you don’t have enough money in your HSA to cover your deductible, you could find yourself having to come up with additional funds out of pocket. For this reason, you should seriously consider using some or all of your premium savings a high-deductible plan offers to jump start funding your HSA. While the significant reduction in premiums often makes HSAs very attractive compared to alternatives, it’s important to realize that HSAs shift risk away from the insurance company and back to the consumer.
What can I use the money for?
You can use the money in your HSA for things like doctor and dental visits, health plan copayments, glasses and contact lenses, prescriptions, and even some common over the counter medicines. The IRS determines the full list of eligible medical expenses, but if you spend HSA funds on something that’s not eligible, you will be subject to income tax and an additional 20% penalty if you are under age 65, so contact your health plan if you’re unsure whether an expense qualifies. In addition, your HSA provider or their website should be able to provide you a list of qualifying medical expenses.
HSAs in retirement
Most people are either unaware that they can invest the money in their HSA, or they fail to do so. But the tax advantage of HSAs, especially the fact that withdrawals for medical expenses are not taxed, actually make them a great way to save for your later years. As an added bonus, as referenced above, once you are 65 or older, you are no longer subject to the 20% penalty should you need to use HSA funds for non-medical related expenses, which provides additional flexibility. Investing your unspent funds in a similar way to those you might contribute to a 401(k) or IRA can maximize their usefulness when you retire. That’s good, because a recent survey found that the average retired couple age 65 in 2021 will need nearly $300,000 to cover health care costs in retirement. Your financial advisor can help you determine the right investment strategy for your HSA funds, but the upshot is that contributing to an HSA is only the first of two steps. The second is to make that money grow.
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Fidelity Investments. “How to plan for rising health care costs.” Accessed May 14, 2021.