6 must-know basics about HSAs

Allworth Co-CEO Scott Hanson shares some key fundamentals about Health Savings Accounts.

Have you ever heard of a Health Savings Account (HSA)?

They are among the most misunderstood and underutilized investment vehicles out there.

Part of the reason HSAs are not more visible is that even a lot of advisors don’t understand them. In fact, in a recent survey, 40% of advisors admitted that they don’t even know the basics of how they work.¹

I think another reason HSAs are not more popular has to do with the name. Any name that has the words “health” and “savings” in the title is going to cause people to either turn away or fall asleep.

With that in mind, especially if you are many years from retiring (or from turning age 65), don’t automatically ignore HSAs, because for those who are eligible to participate, they are a terrific savings and wealth building instrument.

Here are the basics of Heath Savings Accounts.

1. What are HSAs?

Established in 2003 as part of the Medicare Prescription Drug, Improvement, and Modernization Act, a Health Savings Account is a savings and investment vehicle that lets you set aside pre-tax money to pay for many (though not all) types of medical expenses. (However, as I’ll explain in a moment, the money in an HSA does not necessarily ever have to be used to cover your medical expenses.)

2. Who can contribute to one?

You are eligible to contribute to a Health Savings Account if you are covered by certain High Deductible Health Plans (HDHP). For 2022, you may be eligible to open an HSA if you’re single and your healthcare deductible is at least $1,400, or $2,800 for families.

A few of the other rules about who can open a Health Savings Account include:

You can’t be covered by any other medical plan (aside the high deductible one)
You aren’t enrolled in Medicare
You are not claimed as a dependent on someone else’s tax return
You are not covered for medical benefits by the Veteran’s Administration (though there are a few exceptions)

3. How much can you contribute?

Each year, the IRS determines the maximum amount eligible people can contribute to an HSA. For 2022, it’s $3,650 for individuals and $7,300 for families. Additionally, you may be eligible for a “catch-up” contribution of $1,000 if you are 55 years of age or older.

4. If you are eligible, where can you find an HSA to contribute to?

Some employers and healthcare plans offer HSAs to their HDHP participants. But if you’re otherwise eligible, and your employer doesn’t offer one, you may be able to set one up through your bank or some other financial institution (speak with your advisor).

5. Why are HSAs such good savings vehicles?

Among the key benefits of an HSA is that it offers participants three significant tax breaks. First, contributions are pre-tax, so they lower your taxable income. Second, the funds in your HSA grow tax-free. And third, when you withdraw the money for qualified medical expenses, those withdrawals are also tax-free.

But the benefits and advantages hardly end there. For instance, when you reach age 65, you can withdraw the money and use it for general living expenses (you’ll just have to pay taxes on it), but unlike a 401(k) or IRA, no matter how old you are, you are never required to take minimum distributions.

Another great feature of HSAs are their flexibility. For instance, even though you may be enrolled via your employer, unlike the healthcare plan itself, the HSA is yours and stays with you, even once you leave the company. Additionally, unlike Flexible Spending Accounts, your HSA is not a “use-it-or-lose-it” instrument. That is, the balance in the account carries over (and grows) each year.

While the money in an HSA is intended exclusively for medical expenses until you reach age 65, that doesn’t mean you have to use it. In fact, you could elect to pay a medical expense today out of your own pocket, and then take a tax-free distribution from your HSA at some future point in time in the amount of the expense (just hold onto your receipts).

Lastly, the name Health Savings Account is, if not misleading, not a clear representation of the scope of its versatility. That’s because the money in an HSA isn’t just sitting around waiting for you to go and see the doctor, it’s busy working for you. That is, just like an IRA or a 401(k), the money in an HSA can be invested in everything from equities to bonds (where, as mentioned earlier, it’s growing tax-free if used for medical expenses, and it’s growing tax-deferred if used for general expenses after age 65).

6. What are the downsides of HSAs?

Nothing is perfect, but when it comes to HSAs, there are not a lot of drawbacks. Obviously, not everyone is eligible to contribute to an HSA. And the contribution limits are, compared to a 401(k), low. Also, once you turn 65 (the age of Medicare eligibility), you are no longer allowed to contribute to one, even if you are still employed. And, lastly, if you use the money in your HSA for non-medical expenses prior to turning age 65, not only do you have to pay income tax on the withdrawal, but you’ll also get hit with a 20% penalty.

But aside those limitations, if your retirement is still at least a few years away, and you are eligible and able to contribute, an HSA can be a terrific mechanism to build wealth for the future.

Interested in whether you qualify to contribute to an HSA? Speak with a fiduciary advisor who understands them to determine if it’s a viable vehicle for you.

¹ ^{Breaking Down The Basics Of HSAs (forbes.com)}