Wading through health insurance options when starting a new job or during open enrollment can be confusing. The alphabet soup of terminologies sure doesn’t help.
For instance, if your PPO is an HDHP you might be able to open an HSA and save money toward your health expenses. Huh?
In this article, we’ll demystify some of that medical insurance jargon and explain the benefits, rules and nuances of health savings accounts so you can make the best decision for yourself and your family.
What Is an HSA?
HSA stands for health savings account, which is distinctly different from a regular savings account. A health savings account is a tax-advantaged account you and your employer can contribute to in order to pay for eligible medical expenses using pre-tax dollars.
You can use your HSA funds to pay for medical costs as you incur them or let the money in your HSA account grow by investing those dollars.
There are a bunch of financial benefits with having an HSA, which we’ll discuss later, but first it’s important to know how to open a health savings account.
How Do You Open a Health Savings Account (HSA)?
The first thing you should know about an HSA is that you need to have a high deductible health plan, or HDHP, in order to be able to contribute to one.
With high-deductible health plans, you generally pay less in premiums but have to meet a high annual deductible before your plan pays.
A deductible is the money you pay out-of-pocket before your health insurance kicks in and starts providing certain benefits. The premium is the monthly fee you pay to get health coverage.
You can’t open a health savings account with just any health plan with a high deductible. According to the Internal Revenue Service (IRS), the deductible has to be no less than $1,400 for an individual or $2,800 for a family to qualify as a high deductible health plan in 2022.
In addition, in order to be eligible to open an HSA you can’t be enrolled in Medicare, have other health coverage or be claimed as a dependent on someone else’s tax return.
But if you do meet all those criteria, you’re in — even if your employer doesn’t offer a way to open one.
Banks, insurance companies and other qualified HSA trustees offer health savings accounts. Your health insurance company may partner with a financial institution where you can set up your HSA.
HSA Search is a comparison site that allows you to evaluate different HSA providers to find the best one for you.
HSA Contribution Limits
Similar to other tax-advantaged accounts like a 401(k) or IRA, the IRS puts a cap on how much money can be contributed to an HSA in a given year.
In 2022, you can contribute up to $3,650 for individuals or $7,300 for families. If you’re 55 or older, you can contribute an additional $1,000. These contribution limits include any HSA funds your employer adds to your account.
Any savings you don’t spend in a current year rolls over year after year, and the money in your HSA stays with you even if you switch insurance plans, change jobs or retire.
HSA Qualified Medical Expenses
You don’t have to pay taxes when spending your HSA dollars on qualified medical expenses.
The IRS has an entire list of qualified expenses, which includes, but is not limited to:
- Over-the-counter medication
- Dental care
- Eye glasses
- Chiropractic care
- Breastfeeding supplies
- Menstrual care products
- Birth control pills
- COVID-19 home tests and PPE (personal protective equipment)
You’ll usually receive a debit card or checks to spend your HSA money, but in some cases, you’ll have to pay out of pocket and get reimbursed later.
When you spend money from your HSA, make sure to save receipts, explanation of benefits forms or other types of documentation.
“You don’t have to send any documentation to your HSA provider,” said Paul Fronstin, director of the health research and education program at the Employee Benefit Research Institute. “The IRS requires that you have documentation, and if you get audited, you’re going to need that documentation.”
The Benefits of an HSA
A health savings account allows you to save for various medical expenses without being taxed on that money.
If you have this benefit through your job, your employer can direct a portion of your paycheck to your health savings account before taxes are taken out. If you fund your HSA with income that’s already been taxed, you can deduct your contributions when filing your income taxes.
“The advantage of contributing through payroll is you save not just federal and state income taxes, but you also save on FICA taxes,” Fronstin said.
Acronym alert: FICA stands for the Federal Insurance Contribution Act. FICA taxes are what you pay to fund Medicaid and Social Security.
You also aren’t taxed when you spend HSA dollars, provided you’re spending the money on qualified medical expenses.
Another benefit of having a health savings account is that you don’t have to pay taxes on the interest or investment returns as your HSA balance grows.
“If you open an HSA, the money goes into a bank, and it earns interest like a bank account,” Fronstin said. “The interest rates are not high, but once you have a certain amount of money in your account… your HSA provider will likely permit you to invest that money in mutual funds.”
Besides all those tax advantages, another upside of an HSA is that your employer — and other individuals — are allowed to contribute to your account. Can you say free money?
The Challenges With HSAs
One thing to keep in mind when you have an HSA is that you may be charged a fee to maintain your account. Also, if you use the money for something that’s not a qualified expense and you’re younger than 65, you’ll be taxed on it plus you’ll be hit with a 20% penalty.
After you reach age 65, you can use your HSA savings for nonmedical expenses without incurring a penalty, but you’ll still be taxed for it.
Other challenges exist — not with health savings accounts directly, but with having a high deductible health plan. Deciding which health insurance plan is right for you and your family is a personal decision, Fronstin said, and opting into a high deductible plan won’t be the right choice for everyone.
Some people aren’t able to pay for health costs out of pocket before meeting their deductible. For some, that means forgoing medical care.
High deductible health plans have also been criticized as only working for young, healthy people who don’t need much medical care. Standard preventive care, like an annual checkup, is generally covered under a high deductible health plan without having to reach your deductible. But patients who have ongoing medical needs could end up spending a lot of money before getting any benefit from their insurance.
However, changes made by the federal government in 2019 expanded the list of what’s considered preventive care and now includes 14 treatments, medications or devices for people with ongoing conditions like diabetes and heart disease.
“These plans became a little more friendlier for people with chronic conditions,” Fronstin said.
HSAs vs. FSAs vs. HRAs
Health savings accounts aren’t the only tax-advantaged savings vehicles for health care expenses. Flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs) are other options.
A flexible spending account allows you to put aside tax-free dollars to use for eligible medical expenses, but a key difference with the FSA compared to an HSA is that the FSA is owned by your employer. If you leave your job, you forfeit the money in your FSA. Also, you have to use all the money in your FSA within the calendar year, because funds generally do not roll over. The contribution limits also differ.
One key advantage of an FSA: You don’t have to have a high-deductible health plan in order to open one. They can be used in conjunction with any type of health insurance plan.
A health reimbursement arrangement is another employer-established benefit plan, and only your employer can contribute funds toward your HRA.
If your job sets up an HRA for you, you can be reimbursed for qualified medical expenses, tax free. You don’t have to report HRA reimbursements on your income tax return.
All three options can help you save money on medical expenses. Consult with your company’s human resources department for more information on what your job offers so you’re able to make the best decision based on your individual situation.
Nicole Dow is a senior writer at The Penny Hoarder.