Health Savings Accounts (HSAs) are accounts specifically designed to help you pay for medical expenses. They are similar to IRAs (retirement) and 529 Plans (education), but can result in even larger tax savings when utilized correctly. Below are answers to the most frequently asked HSA questions.
Can you explain the basics of an HSA account and its contribution limits?
You can think about an HSA account as a way to get a significant discount on your medical costs. It allows you to put aside funds to pay for qualified medical expenses, up to an annual limit. Those funds avoid all income taxes (except for California and New Jersey, where state income taxes are still applied). If your HSA is investable, the earnings are also tax free, as long as all withdrawals are used for qualified medical expenses. HSA accounts are the “triple tax advantage” accounts - contributions of untaxed money, no tax on earnings, and no tax on qualified withdrawals. A trifecta of tax savings.
Who can contribute to an HSA? What kind of health insurance plan is required?
Coverage by a qualified high-deductible health insurance plan is necessary to be eligible for HSA contributions, and not all high-deductible plans qualify. HSA-eligibility is usually stated in the plan name or in the plan description.
What if I was covered by an eligible plan for a portion of the year?
There are two contribution options for a year with partial coverage:
1) make prorated contributions based on months of coverage, or
2) elect the last month rule: if you were covered by an eligible plan on the last day of the year, you could max out the contribution for the year but only if you will maintain coverage by a qualified plan through the end of the following calendar year. If you lose eligibility before the end of the following year for any reason other than disability or death, any contributions in excess of the prorated amount are included in your taxable income, plus subject to an additional 10% penalty.
What are the contribution limits?
The HSA contribution limits for 2024 are $4,150 for self-only coverage or $8,300 for a family, including employer contributions. These tend to get increased by a bit every year or two. Any contribution from your employer does count against this limit - if the employer adds $1,000 then the amount you can contribute is reduced by $1,000.
Are there limits on HSA distributions?
There are no limits on HSA distributions, and you do not need to be covered by a qualified healthcare plan to be able to make distributions. The coverage requirement only applies to being able to make HSA contributions. Distributions for eligible medical expenses are tax-free and penalty-free. However, distributions that are not for qualified medical expenses are taxed, and come with a 20% penalty unless you are 65 or over.
How do catch-up contributions for people over 55 work?
Annual contribution limits are increased by $1,000 for those over 55. If two spouses have separate HSA accounts and both are over 55, total additional contribution could be up to $2,000.
How do employer contributions to an HSA work?
Employers usually make HSA contributions automatically every pay period, and the total amount contributed to your account over the course of the year is listed on your Form W-2. That amount is then stated as employer contributions on Form 8889 of your tax return, allowing you to calculate what additional amount can still be contributed for that tax year. You can make any additional contributions after year end by the due date of your tax return, usually April 15, similarly to IRA contributions.
What sorts of medical expenses can HSA funds be used for? Are there limits?
The funds can be used to pay for medical expenses that would be eligible to be deductible as an itemized deduction as defined by the IRS in Publication 502. Cobra premiums, fertility treatments, over-the-counter medicines, healthcare expenses later in life (including Medicare premiums if over 65), and long term care premiums up to an age-based limit are some examples of how HSA funds can be used, in addition to the more common medical, dental, and vision costs. HSA accounts do not have expiration dates, so you could use them for future medical expenses.
What if I never have significant medical bills and end up with a large HSA balance?
After the age of 65, you can withdraw funds from your HSA for any purpose without any penalties. These however would be subject to income tax. Essentially, once you are above the age of 65, your HSA acts very similarly to a traditional IRA.
What are the biggest advantages to an HSA account?
The income tax savings aspect of HSAs is the main advantage, followed by the fact that those funds are yours to keep, even when you are no longer covered by a qualified high-deductible health plan. Unlike FSA plans that often work on a “use it or lose it” basis, HSA funds do not have an expiration date whatsoever. In addition, you don’t have to have earned income to be eligible for contributions.
Are there any drawbacks to having an HSA account?
You do need to be covered by a qualified high-deductible health insurance plan, and for somebody with, for example, a chronic illness that requires regular expensive care, the tax savings from having an HSA account might not outweigh the high out-of-pocket medical costs associated with a high-deductible plan.
Also, If you have to take money out of HSA without having qualified medical expenses, the tax penalty is steep - 20%, plus you will have to pay income taxes on those disqualified distributions.
What circumstances or situations make someone a good fit for an HSA account?
If you are eligible to make an HSA contribution and have the means, funding your HSA is a no brainer. If you have to pick between funding your IRA and an investable HSA, going for the HSA could be a wise choice, because HSAs are the only triple-tax-advantage accounts out there.
Should I contribute from my paychecks or transfer funds directly into the HSA account?
The advantage of payroll contributions is that the contributions would be exempt from the FICA taxes: social security at 6.2% and medicare at 1.45%, plus potential 0.9% medicare surcharge for high earners; even if you are over the social security limit ($168,600 for 2024), you are still on the hook for medicare tax an all earnings.
Eligible contributions made directly into the HSA account would receive the corresponding income tax deduction, but the FICA savings would not be available.
The drawback of payroll contributions is that most likely you will not be able to front load those, potentially missing out on investment earnings. This is particularly applicable to those who are using HSA accounts as investment vehicles and are not seeking to dollar cost average the contributions throughout the year.
Should I pick a High-Deductible Plan (HDHP) to qualify for an HSA or choose a low-deductible plan without an HSA?
It depends primarily on anticipated usage. If you don’t incur larger medical bills, then an HDHP could save you money, and an HSA could be a great investment tool. If you end up with high medical costs during the year, then the higher premiums and lower deductibles may be advantageous. Here is a simplified formula: total expected healthcare costs less employer contributions less tax savings from HSA contributions. If that results in a number smaller than total expected costs from the alternative low-deductible plan, then a HDHP with an HSA might be the “spreadsheet” answer. Total “expected healthcare costs” here are premiums plus whatever you expect to spend on medical costs up to “out of pocket max” of the plan, depending on anticipated usage.
One important consideration is whether having a high-deductible plan would prevent you from getting the needed care. Your health is your main asset, and skipping on a diagnostic visit for the sake of saving some money might backfire.