How to Use a Health Savings Account and Why You Should Start One Today

Health Savings Accounts (HSA) have been around since 2003 to help individuals covered by high-deductible health plans (HDHP) save money for medical expenses. Though these accounts have been around for a long time, there are still many questions about them.

What is an HSA?

According to the IRS, an HSA is one of many types of programs designed to provide tax advantages that offset the cost of health care. An HSA is a type of savings account that you can set up through a qualified HSA trustee (bank, insurance company, etc.) that allows you to set aside money on a pre-tax basis to pay for qualified medical expenses (for a full list of qualified medical expenses, see IRS publication 502).

To qualify for an HSA as an eligible individual, you must first have medical coverage under an HDHP by the first day of the last month of your tax year (which is normally December 1 for most taxpayers), you can’t have any other health coverage except for the HDHP, you can’t be enrolled in Medicare, and you can’t be claimed as a dependent on someone else’s tax return.

If you meet all of the criteria set by the IRS to be an HSA eligible individual, you can set up an HSA account through an institution of your choice, or you may have access to an HSA account set up through your employer. Once you have an HSA set up, you or someone on your behalf (for example, your employer, family members, etc.) can make contributions to your HSA up to the IRS contribution limits for the year. For 2021, if you qualify for self-only HDHP coverage, you may contribute a total of $3,600 to your HSA. If you qualify for family HDHP coverage, the total contribution amount is $7,200. If you are age 55 or older by the end of your tax year, then you can contribute an additional $1,000. Keep in mind, though, if your employer makes contributions to your HSA, you must reduce the amount you or anyone else makes to your HSA to stay within the IRS contribution limits.

Why should I contribute to an HSA?

If you are covered by an HDHP, there are a few reasons why you would want to contribute to an HSA. One reason is that you can claim your contributions that you or someone else makes to your HSA as a tax deduction. Keep in mind, though, you cannot claim a tax deduction for any amount your employer contributes to your HSA. Another reason you should make contributions into an HSA is that the contributions your employer makes can be deducted from your gross income. If your employer is making contributions or matching any contributions you are making to your HSA, that is free money that you don’t want to leave behind. Any contributions made to your HSA remain there for you to use for qualified medical expenses tax free throughout the year for yourself, your spouse or for your dependents.

If you don’t use all of the funds in your HSA by the end of the year, any funds left in the account generally carry over to the next year for other medical expenses. If you have excess money in your HSA, you can invest that money or it can earn interest and those earnings are tax free. Another benefit is that the funds in your HSA are yours and they are “portable.” This means if you change jobs or leave the workforce, you keep your HSA. If you have your HSA set up through your former employer, it is possible to roll it over to a new one.

How much should I contribute to my HSA?

If you have an HSA and you are qualified to make contributions to it, another question you may ask is “how much should I contribute?” Wex Marketing, in their 2020 article “How much should I contribute to my health savings account (HSA) each month?” recommends you contribute “as much as you’re able to (within IRS contribution limits…if that’s financially viable).” Another way to say this is however much you can comfortably afford while remaining within the IRS contribution limits.

How do I use my HSA funds?

You can use your HSA funds to pay for qualifying medical expenses quickly and easily throughout the year for yourself, your spouse, or your dependents. If you don’t use those funds immediately, then they will remain in your account, growing tax free, and can be used for future medical expenses or for retirement. If you are age 65 or older, you can use the funds in your HSA account for non-qualified medical expenses without penalty, you will just have to pay taxes on the withdrawn amount.

Other considerations

There are some other considerations you should keep in mind when trying to determine how to use your HSA.

One very important consideration is when you use your HSA for a qualifying medical expense or you withdraw from your HSA for any reason, be sure to keep all of your receipts. You may be required to show proof of qualifying expenses for as long as you have an open tax return or, in some instances, for as long as your HSA account has been open.

Another consideration is that you can use your HSA for non-qualified expenses, but if you are not yet 65 year old, you could be subject to paying income tax as well as a 20 percent penalty on the amount being withdrawn. If you are over age 65, there is no penalty for using the funds for non-qualified expenses, but you are still required to pay taxes on the amount withdrawn. Also, if you plan to invest some of the funds in your HSA, you may want to keep a large enough portion of those funds accessible to cover any possible medical expenses. Jeff Rose, a contributor for Forbes, clarifies this by saying, “HSA funds can be invested. But you have to be careful investing, since the funds may have an immediate need. That means you may want to keep a certain amount in liquid form, then invest any excess. A good rule of thumb will be to keep an amount sufficient to cover your health insurance out-of-pocket maximum in liquid form.”

Managing an HSA is a great way to prepare for unexpected medical expenses. If you are interested in learning more about these accounts, contact your ARC representative today.