Health savings accounts (HSAs) can be a helpful tool for building wealth and covering expenses. However, they’re still relatively new—legislation paved the way for HSAs in 2003—and not everyone qualifies. Let’s look at what HSAs are; who qualifies to use an HSA; how to get the most out of an HSA; and how HSAs fit into an overall financial plan.
What are HSAs?
HSAs are tax-advantaged savings accounts that can be used to cover qualified healthcare expenses, as determined by the IRS. Deductibles, coinsurance, medical equipment, prescriptions, and copayments all tend to count as qualified expenses.
HSAs don’t just help you save (and pay) for medical expenses—they offer a triple tax advantage.
- The money contributed to an HSA is pretax, meaning it lowers your taxable income for the year the contribution is made.
- Earnings grow tax-free. Keep in mind this is federal tax, and earnings may be subject to state tax (as they are in California).
- Withdrawals are tax-free, as long as they’re used for qualified medical expenses.
As with other tax-advantaged accounts, HSAs do have contribution limits, which the IRS revises periodically. Compared to 401(k)s and IRAs, the annual limit is fairly low—$3,850 for an individual in 2023 or $7,750 for a family, with the option for catch-up contributions if you’re older than 55.
On the other hand, HSAs offer more flexibility around timing. You could use HSA funds for medical expenses now, if you choose, or use the account as a tool to save for health care costs in retirement.
Remember, health care costs tend to increase over time, and the amount of health care you require may increase as you age.
As an added benefit, after you turn 65, the funds in your HSA can be used to cover non-medical expenses, though non-qualified withdrawals are subject to income tax, similar to IRA withdrawals. While building savings for retirement isn’t the primary purpose of an HSA, it can help supplement your other income sources in a tax-efficient way.
One final note: If you withdraw funds from an HSA for nonqualified medical expenses before you turn 65, you’ll need to pay a 20% penalty on the withdrawal and income tax.
Qualifying for an HSA
While HSAs offer significant tax and planning benefits, they aren’t for everyone.
To start, you must be enrolled in a high-deductible health plan (HDHP) in order to qualify. The IRS adjusts the exact criteria for a “high-deductible” plan every year based on inflation.
For 2023, HDHPs must have deductibles greater than $1,500 for individuals or $3,000 for families, and out-of-pocket maximums of at least $7,500 and $15,000, respectively. Normally, HDHPs are labeled as such so you don’t need to look up the specific criteria.
You qualify for an HSA when you enroll in an HDHP through your employer, a spouse’s employer, or through your state’s healthcare marketplace. Not every employer offers an HDHP option. Of the employers that do, some offer an employer match for employee contributions. For example, your employer might match $500 for individuals or $1,000 for families. Just keep in mind, these employer matches count toward annual maximum contributions, which is different than an employer match on a 401(k).
Keep in mind: While you may qualify for an HSA through a workplace benefits package, the account is tied to you and not the job. The funds in the account don’t expire at the end of the year, as they would with a flexible spending account (FSA), or if you switch jobs.
Maximizing your HSA
HSAs can help with rising health care costs, retirement planning, tax strategy, and more. At Quorum Private Wealth, we consider a number of factors when incorporating an HSA into a financial plan.
- Prioritize your health. If you have significant medical expenses, the benefits of a more robust healthcare plan may outweigh the tax and planning advantages of an HSA. We encourage our clients to look at their medical history and consider any anticipated medical expenses before switching to an HDHP (the prerequisite for an HSA).
- Prioritize retirement accounts. HSAs can be a fantastic tool, but they generally work best as a supplemental savings account. We generally recommend clients develop a plan to max out other retirement benefits, like a 401(k) and IRA, before focusing on HSAs.
- Max out contributions. This includes taking advantage of any employer match.
- Think beyond retirement. Remember: HSAs were designed to help with medical expenses. If you do have a large, unexpected medical expense, the HSA can help with that. However, there are times that it may make more sense to pay out of pocket; a financial advisor can help you evaluate your choices.
Taken in concert, we can help qualifying clients decide if and when it makes sense to fund an HSA, as well as when it may make sense to access those funds.
If opening an account is something you’re interested in doing, we can work together closely to determine if an HSA makes sense for you and how to best incorporate contributions into your greater savings strategy.
Sources: IRS, Kaiser Family Foundation
