What Exactly Is an HSA?

A health savings account, or HSA, is a type of savings account that allows you to save money for medical expenses before taxes. It's convenient to keep for medical costs while also lowering your taxable income.

However, not everyone can or should enroll in the type of health insurance plan required to use an HSA. Here's how health savings accounts work and how they can help you.

Eligibility For An HSA

To contribute to an HSA, you must first enroll in a high-deductible health insurance plan, also known as an HDHP, as defined by the government. The IRS redefines high-deductible health plans each year, determining the minimum deductible and the maximum amount a plan holder can spend out of pocket. In 2022, for example, an HDHP must have a deductible of at least $1,400 for an individual or $2,800 for a family, with a maximum out-of-pocket spending limit of $7,050 for an individual or $14,100 for a family.

Keep in mind that some plans have high deductibles but do not allow you to contribute to an HSA. If you want the account option, look for plans specifically labeled "HSA-eligible."

How Does An HSA Work?

Some employers who provide high-deductible health plans also provide HSAs. If yours does not, if you have a qualified plan, you can start a second HSA.

You choose how much to contribute to your HSA each year, but you cannot exceed the government-mandated maximums. People with self-only coverage can contribute up to $3,650 to an HSA in 2022, while those with family coverage can contribute up to $7,300.

If you have an HSA via your employer, you may set up direct payroll contributions. You'll be given a debit card or checks connected to your HSA balance, which you can use to pay for qualified medical costs.

Your HSA balance, unlike a flexible spending account, rolls over from year to year, so you never have to worry about losing your funds. You can no longer contribute to an HSA if you are over the age of 65 and enrolled in Medicare, but you may still utilize the money for out-of-pocket medical expenditures. If you spend the money on non-eligible costs, you must pay income tax on it (plus a 20% penalty if you are under 65).

Expenses That Are HSA-Eligible

HSA money can be used to pay for deductibles, copays, and coinsurance, as well as over-the-counter medications, feminine hygiene products, and other eligible medical costs not covered by your insurance plan.

Generally, HSA money cannot be used to pay for insurance premiums. However, you can use HSA funds to pay for COBRA health coverage or to pay health insurance premiums if you get unemployment benefits. Furthermore, if you have Medicare, you can utilize HSA money to pay Part B and Part D premiums. In addition, if you are 65 or older, you can utilize HSA funds to pay for employer-sponsored health care premiums, if applicable.

The Benefits of HSAs

HSAs provide significant tax advantages.

Contributions Are Tax-Deductible.

Contributions to an HSA are either pretax (if made through an employer) or tax-deductible (if you make your own contributions). As a result, every dollar you put into an HSA is one less dollar you'll have to pay taxes on. For example, if you earn $40,000 per year and contribute $3,000 to your HSA, you will be taxed as if you earned $37,000, minimizing your tax burden.

Growth In Your Account Is Tax-Free.

Your HSA funds can be invested in mutual funds, equities, and other financial instruments. Depending on your investment choices, several businesses can assist you with this. Find an HSA custodian who enables investing and offers low-fee investment alternatives if you intend to invest your HSA balance.

Withdrawals Are Not Taxed.

Withdrawals from an HSA are tax-free as long as they are used for qualifying medical costs.

Your Employer May Make A Contribution.

Employers, like 401(k) plans, can direct cash to qualify workers' HSAs. Unlike a 401(k), however, this money normally does not require a matching employee contribution. This benefit is provided by around 82% of companies, and the contribution counts against the employees' contribution threshold.

HSA Disadvantages

HSAs provide several advantages as a savings vehicle. But there is one major caveat.

You Must Have A High-Deductible Health Insurance Plan.

An HDHP requires you to have the financial means to satisfy a high deductible before the insurance begins paying for covered health care. You pay for all medical expenses out of pocket until you reach your deductible. If it is out of your price range, an HDHP (and associated HSA) may not be the best solution for you.

Consider your health care requirements first, followed by your savings and investment needs when considering whether to contribute to an HSA. An HSA may be a great financial tool if you choose an HDHP for your health care.