This is the third post in a 5-part series on health insurance. We’ve explored what to do when your employer cancels your health insurance plan and how a high-deductible health plan works. In the next few weeks, we’ll also look at how we save thousands on our health insurance bill, and using AFLAC for pregnancy.
At this point, we’ve taken a look at how HDHPs work and why they may be an awesome alternative for you if you’re shopping around for insurance. One of the primary benefits of an HDHP is the ability to open a health savings account, or HSA. Today, we’ll take a look at why HSAs are beneficial and how they help us meet our health care goals.
The Basics of an HSA
An HSA, in its simplest terms, is a savings account that is used to pay for health care expenses. Contributions made to this account can usually be tax-deducted, up to a certain yearly limit, and withdrawals used for health care are also tax-free. Funds don’t “expire,” meaning they accumulate from year to year.
HSA were introduced in the early 2000’s and continue to evolve. For example, the recent health care law eliminated the ability to purchase over-the-counter drugs using HSA funds.
Who can open an HSA?
Not everyone can. The big requirement is your enrollment in a qualified high-deductible health plan. Even if your deductible limits exceed that of an HDHP, you might not qualify. Your insurance company is the go-to contact for questions. Most will categorize plans as either eligible or not eligible for HDHP status, and therefore an HSA.
How Can You Use HSAs?
Once you open an account with one of the hundreds of institutions qualified to administer them (we keep ours with Wells Fargo), you can start making deposits. Depending on how the plan is set up, you or your employer make deposits through your paycheck, directly into the account, or some other method.
Based on tax limits, you can deposit about $3K in the account every year if you’re on the plan alone, or about $6K per year for a family. This is adjusted every year for inflation and other factors. In many cases (ours included), this amount more than covers your total annual deductible, even if you were to use 100% of it. Even if it didn’t, remember that funds can accumulate, so it’s possible to save up a considerable stash of health care money in this account.
Withdrawing from HSAs can be as simple as pulling out a separate debit card at the doctor’s office or writing a check. Most HSA accounts are not “restricted,” which means it’s your responsibility to make sure that what you’re buying or paying for is a qualified expense. If you’re ever audited by the IRS, you’ll have to produce proof that your spending was health-related as defined by the IRS (PDF).
Benefits & Drawbacks of HSAs
Now that you understand the basics of what HSAs are all about, let’s look at some of the benefits and drawbacks specific to these account types. Here are just a few of the benefits:
- Deposits to HSAs are tax-deductible “above the line,” which means they can usually be taken even if you don’t itemize other deductions (similar to student loan interest, for example).
- You can use HSAs to cover a huge variety of medical expenses, even if they’re not covered by your health plan, like dental bills, alternative medicine, or eye care.
- You can invest funds deposited in your HSA and the accounts grow tax-free.
- HSAs aren’t tied to a specific plan, don’t have to be used during a certain year, and can be maintained much like an IRA would be to fund health expenses in retirement.
- If you reach 65, you can keep using your HSA for medical expenses, or withdraw money much like you would with a traditional IRA, just by paying taxes.
How about some potential drawbacks? A few come to mind:
- If you’re not 65 yet and need to withdraw for non-health expenses, you’ll probably have to pay the taxes and a penalty, currently 20%.
- Tax and use regulations change regularly, and future changes may affect how we can use the funds in our HSAs.
- There are often maintenance costs associated with these accounts, either on a monthly or per-transaction basis.
What Do I Think?
We’ve had our HSA and HDHP for almost a year now, and so far I’ve loved it. We’re in complete control of our health spending and can put away the money we would have otherwise spent on health premiums into the account to save & grow. When doctor’s bills or unexpected illnesses come up, I know we already have the money to cover these expenses. It’s great peace of mind.
Do any of you currently have HSAs? What are your thoughts?
Note: This post covers the basic principles of HSAs as of the time of this writing and based on my personal knowledge. You had better consult with your tax/financial professional before you make a move if you’re unsure about anything!
Photo by hill.josh
Fiscal Fizzle 
One of the best explinations of an HSA I have seen
We’ve had an HSA for several years. Ours currently has around 26k in it. About four years ago, we started paying all healthcare expenses out of a separate (taxable) account. This allows our HSA to grow tax free. In effect, it’s another roth IRA (only better since the money goes in pre-tax).
We store ours at Alliant FCU. They pay one of the best rates I’ve found on HSA savings (currently 2%… which is over 3% in taxable equivalent yield).http://www.alliantcreditunion.org/depositsinvestments/healthsavings/
Our thinking is that this will be a nice little health care earmarked nest egg for retirement.
One other thing that’s important to realize. Currently, you’re allowed to save your healthcare receipts from previous years, and withdraw from the HSA for those receipts in future years. So… if we retire before 65, we’ll be able to withdraw a big chunk from our hsa (up to the amount we have in receipts), if we choose to. This is one thing that I suppose could change with future tax policy, but my understanding is that this is how it works today.
To me, HSAs seem like they are even better than a Roth (since the money goes in pre-tax and it and the earnings on it are NEVER taxed). The only problem is the lack of investment options (but I’m reading where Fidelity and some brokers are beginning to allow trading in stocks and funds from within an HSA account).
Incidentally, it’s pretty easy to join Alliant if you have kids. You just need to be a member of the PTA in whatever school district you’re in. As I understand it, Alliant is the public school teachers credit union.