Why a Health Savings Account (HSA) Is a Good Deal
A health savings account (HSA) is a type of bank account that helps you reduce your taxable income while saving money on a range of health care expenses.
By using an HSA, you could save $840 per year on taxes, and a family could save $1,679 per year.
Money in an HSA can also roll over from year to year. This can provide a rainy day fund for medical expenses, or it could be used as a retirement savings tool to pay for Medicare or other out-of-pocket costs.
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How does an HSA work?
Health savings accounts (HSAs) allow you to put pretax money into a savings account and use that money for medical expenses, without ever paying income taxes on it.
You can only contribute to an HSA if you have a high-deductible health plan (HDHP). And funds in an HSA can earn interest, growing your account balance if you don't spend the money.
Once your account is open, you can request a debit card (or, in some cases, checks) that you then use to pay for qualified medical expenses such as prescription drugs and prescribed medical tests.
Employers can also contribute to HSAs on your behalf, providing even more funds you can use for health-related expenses.
The maximum annual contribution to an HSA is currently $3,650 for individual account holders and $7,300 for families. These limits pertain to any contributions made by you or your employer. Those age 55 and older can make an additional $1,000 annual contribution.
For example, let's say you have an annual income of $50,000, and you’re expecting medical bills totaling $3,000 in the coming year, perhaps because you want laser eye surgery to correct your vision, or you have a chronic condition that requires regular care and monitoring, or you had a baby or a worrisome symptom that required extensive medical testing. You can pay these expenses using untaxed money you have in an HSA, as long as the account was established before you incurred the expenses.
Is an HSA worth it?
If you expect to have any health expenses, ever, an HSA allows you to pay them with pretax dollars.
Since almost everyone eventually faces health expenses, using an HSA to pay for them with pretax dollars can help your money go further.
HSAs offer several tax benefits:
- You can deduct your HSA contributions from your taxes.
- If your employer contributes money to your HSA, the contribution is not included in your total taxable income.
- The interest you earn from an HSA is tax-free.
- When you use your money for qualified medical expenses, the distributions are tax-free.
Importantly, because you can only contribute to an HSA when you have a high-deductible health insurance plan, you are making some trade-offs with your medical coverage. When a plan has a high deductible, you could initially have expensive upfront costs if you need medical treatment other than preventive care. For example, you may need to pay the first $1,400 in health care bills before the plan's cost-sharing benefits begin. However, you can use your HSA funds to pay for this, offsetting the potential expense.
What can you spend HSA funds on?
You can use money in an HSA to pay for your health insurance plan's deductible, doctor and dentist bills, prescription copays, eye exams, contacts and prescription glasses, and medical supplies from bandages to hearing aids.
The list of eligible expenses is long. It even includes expenses that may not be covered by health insurance at all, like laser eye surgery, guide dogs or fertility treatments.
While you usually cannot use HSA funds to pay monthly premiums for health insurance, there are important exceptions. You can use HSA money to pay monthly premiums for:
- COBRA insurance if you lose your job
- Long-term care insurance
- Medicare costs for Parts B, C and D
How much can you save with an HSA?
The amount of money you could save on taxes is based on your federal income tax rate.
For an individual who funds their HSA with the annual maximum of $3,650, the tax savings would typically be between $700 and $1,300 annually. A family could save more than $2,000 per year on income taxes.
Individual
Family
Tax rate | Tax savings with an HSA contribution of $3,650 |
|---|---|
| 20% | $730 |
| 25% | $913 |
| 30% | $1,095 |
| 35% | $1,278 |
Individual
Tax rate | Tax savings with an HSA contribution of $3,650 |
|---|---|
| 20% | $730 |
| 25% | $913 |
| 30% | $1,095 |
| 35% | $1,278 |
Family
Tax rate | Tax savings with an HSA contribution of $7,300 |
|---|---|
| 20% | $1,460 |
| 25% | $1,825 |
| 30% | $2,190 |
| 35% | $2,555 |
HSA funds can roll over or be used as retirement savings
HSAs are portable. If you leave your job or retire, you take the HSA with you. You can also roll over any unused funds year to year. That means if you have $500 in your HSA in December, you do not have to use it or lose it. Any unused funds do not count toward the maximum contribution in the new year, so you can build a nest egg explicitly geared to address health care needs.
Because HSA funds can stay in your account from year to year, you won't risk losing your money.
This makes HSAs more flexible than FSAs (flexible spending accounts) which are also used for medical expenses but have more restrictions.
One caveat: Once you enroll in Medicare, you can no longer contribute to an HSA, but you can keep any leftover funds. These funds can pay for medical costs as well as your monthly costs for Original Medicare (Part B), Medicare Advantage (Part C) or a Medicare prescription plan (Part D), which can total more than $2,000 annually. Your spouse inherits your HSA if you designate them as the beneficiary.
Even though an HSA can be used as a way to save for retirement, the majority of account holders are spending at the same rate they're contributing, taking an average of $1,700 in distributions annually.
Which health insurance plans are HSA-eligible?
You can only make contributions to an HSA if you are enrolled in what the IRS classifies as a high-deductible health plan (HDHP). The definition of this goes beyond strictly the plan's deductible amount.
An HSA-eligible health insurance plan must:
- Have a plan deductible that's higher than the IRS requirement
- Have an out-of-pocket maximum that's lower than the IRS requirement
- Provide no insurance coverage until the plan's deductible has been met, except for preventive care services.
Based on current IRS rules, an HSA-eligible individual insurance plan must have a deductible that's $1,400 or higher. Also, the plan's out-of-pocket maximum must be $7,050 or less — that's lower than the spending cap for some plans sold on HealthCare.gov, which can be up to $8,700.
Self only | Family | |
|---|---|---|
|
HDHP minimum deductible amount | $1,400 | $2,800 |
|
HDHP maximum out-of-pocket amount | $7,050 | $14,100 |
Only 5% of health insurance plans sold on the federal exchange, HealthCare.gov, are eligible for HSAs.
On the Plan Finder, HSA-eligible plans are indicated in the upper left corner of the plan description, or you can filter your local options to only see HSA-eligible plans.
Find out if your plan is HSA-eligible
If you aren’t sure if your health insurance qualifies you for an HSA, call the insurer and ask. If you purchase a plan through a federal or state exchange, the answer should be in the plan information available through the exchange website.
If you qualify for an HSA, you can walk into any bank that offers these accounts (most do) or consider an online bank.
When choosing an HSA, look into any fees you will be charged as well as interest rates and investment options for the money you leave in an HSA.
It’s important to establish your HSA as soon as possible if you expect medical expenses — even if you don’t have the money to fund it right away. That’s because you can only use money in your HSA to pay for expenses that occur after the account was established. Make sure you fund the account while you still have an eligible plan. If you later switch to a noneligible plan, you cannot add contributions for that year. However, you can use the funds that are already in the account for qualified expenses.
If your current health insurance plan isn’t HSA-eligible, despite its high deductible, you’re out of luck for this year. But now that you know how a plan qualifies and how this kind of account might help you every time you have a medical expense — or even if you never do — you can consider the possibility next time you’re choosing a health insurance plan.
Sources and methodology
Estimated annual tax savings of $840 per individual and $1,679 per family are based on contributions up to the federal limit and the average tax rate of 23%.
- IRS Publication 969 on health savings accounts
- Lively’s second annual HSA Account Holder Insights report
- Health Insurance Exchange Public Use Files (PUFs) from the Centers for Medicare & Medicaid Services (CMS)
- HealthCare.gov resources on high-deductible health plans (HDHPs)