What Is a Health Savings Account (HSA)?
As a CERTIFIED FINANCIAL PLANNER™ and a financial coach, I know one thing that's been on everyone's mind lately is being healthy. Making sure that you're healthy has become an important staple of modern life. And with new strains and variants of Covid-19 seemingly emerging everywhere, there's never been a more critical time to make sure that you and your family are as healthy as possible. Health is a funny thing. I say that because, to an extent, we're responsible for keeping ourselves well. However, sometimes that control is taken away from us. For instance, if you were to get the flu, you can't exactly kick it just by taking some vitamins - with instances like that, your healthcare needs to be taken to the professionals.
In 2008 a study indicated that out of roughly 1,400 participants, over half were unlikely to seek medical help if they were sick. Out of those participants, about 1/4th cited the high costs, and others said it was because of lack of insurance that they didn't or wouldn't seek medical attention. I write this to stress that with proper financial planning, health care shouldn't be avoided. If you have the right financial planner or financial coach in your corner, you should be able to tackle medical expenses as easily as anything else.
This brings me to our topic of the day, Health Savings Accounts, or HSAs. Today, we will be talking about what Health Savings Accounts are, who can qualify for them, why some may find them appealing, and the positives and negatives that may sway your decision on whether or not you'd like to have one.
As always... this blog post is for informational purposes. Consult your CERTIFIED FINANCIAL PLANNER™ or Tax Accountant to decide is a HSA is right for your personal financial plan
What IS a Health Savings Account?
So, why all the hubbub? Isn't a Health Savings Account just a savings account that you have for healthcare? Isn't it just like a financial bucket? To answer that question, yes and no. While an informal DIY Health Savings Account may be a bucket you've put aside to save for medical expenses, there's quite a bit more that goes into a formal Health Savings Account.
HSAs were created by the Medicare Prescription Drug, Improvement, and Modernization Act, which was passed and signed into law in 2003. A formal Health Savings Account is meant to create tax advantages for those enrolled in high-deductible Health Plans. In other words, when you go to the doctor, and your insurance won't begin paying for you until you've spent X amount, a Health Savings Account is there to step in and help you cover the difference.
A Health Savings Account operates much like an IRA, in which money is deposited into an account and grows tax deferred until the money is withdrawn. Deposits, also known as contributions are limited by your age and health care coverage.
The money in a Health Savings Account also rolls over year to year. This means that you get to keep what you've deposited and not spent in your HSA(unlike a FSA/Flexible Spending Account), creating a larger and larger pool of money to draw from for medical expenses. The money in your Health Savings Account is there to help you cover qualifying medical costs but can also be withdrawn and used for certain non-medical expenses. However, it's essential to keep in mind that while you may withdraw money at any time, it may come with a penalty depending on your situation.
Tax Advantages of a Health Savings Account
I briefly mentioned that money deposited into a Health Savings Account comes with specific tax advantages. This may come as an excellent option for all of those who are constantly looking for ways to minimize their tax payments. Now… let's go over these tax advantages, how they relate to your HSA, and what they do!
If your Health Savings account is through an employer, you'll get pre-tax contribution advantages! In other words, since part of your paycheck is going directly to a tax-advantaged Health Savings Account, you'll be taxed as if you didn't make the money that was contributed. So, for example, if you made $30,000 and you contributed a $3,000 maximum to your HSA, you'll only have to pay federal taxes on $27,000.
If your Health Savings Account was opened on your own, then you'll have tax deductions waiting for you at the end of the year! In other words, if you work for someone but have opened your own Health Savings Account, your paycheck has already been taxed, so the government potentially allows you to write off your HSA contributions. Likewise, if you work for yourself and pay quarterly estimated taxes, then your HSA contributions could be written off as well. (Check with your accountant!)
Like other retirement or savings accounts, Health Savings Accounts can accumulate interest or it can be invested in other assets! While generally speaking, this isn't a significant return on investment (keep in mind it is a savings account at the end of the day), earnings from money growth through Health Savings Accounts are tax deferred!
Lastly, for taxes, if you are withdrawing money to cover a qualified health expense, that money is tax-free. This means that when you go to the doctor, as long as the expense you're paying for qualifies, you won't have to pay taxes on the money you've withdrawn! This is an incredible option for those who are strapped to high-deductible health plans and can end up saving a ton of out of pocket expenses.
Do You Qualify for a Health Savings Plan?
So, do I have your attention yet? Health Savings Accounts are a great option for some, especially if they want to minimize their tax burdens. However, not just everyone can go out and open a Health Savings Plan. You must qualify in order to open an HSA. So, that raises the question… how do you qualify for a Health Savings Plan? Well, there are several requirements for those who'd like to open a Health Savings Plan… let's go over each one.
For starters, you can't be claimed as a dependent on someone else's tax returns. This could be an issue for some, especially those who are at that in-between age. Individuals may be claimed as a dependent on their parent's tax return until 24 and health insurance until 26. Essentially, this means that if you're a parent, you can withdraw money for your child from your Health Savings Account until they're 26. It also means that you need to check with your family and make sure that they aren't claiming you as a dependent if you're around that age and would like to open an HSA of your own.
You can't be enrolled in Medicare, TRICARE, or TRICARE for Life, and you must have no other health coverage other than what is permitted by the IRS. This one will count out many people, especially those who are military, veterans, or covered by military insurance. You also can't open an HSA if you've received VA benefits in the past three months.
You can't have a Flexible Spending Account, Health Reimbursement Account, or alternative plan designs. These are accounts that also create tax benefits for those saving for medical expenses in one way or another. This is essentially the IRS's way of ensuring you aren't creating a maximum redundancy to evade taxes.
Lastly, and this is the big one, you must be covered under a qualifying high-deductible health plan. Or in other words, the deductible (the amount you pay out of pocket for medical expenses) on your current health insurance plan must be high enough to create a need for you to have a Health Savings Plan and gain those tax advantages.
What Qualifies as a High-Deductible Health Plan?
If you're wondering what counts as a high-deductible health plan, don't worry! Let's quickly review what the IRS defines as an HDHP, or High Deductible Health Plan, which will qualify and allow you to open a Health Savings Plan. According to healthcare.gov:
"For 2021, the IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP's total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can't be more than $7,000 for an individual or $14,000 for a family. (This limit doesn't apply to out-of-network services.)."
What Expenses Qualify for Tax-Free Treatment?
The list of what does and doesn't qualify as a medical expense for a Health Savings Account is really too long to include in an article. Because of this, I'm linking to an excellent resource that goes over the basics of what will and won't qualify. Here you can search for a procedure and see whether or not it's qualifying or non-qualifying by switching between the tabs! This website is very intuitive and makes it super easy to tell what does and doesn't qualify. It's definitely easier than reading through a list.
Annual Deposit Limits and Rollovers
Throughout this article, I've mentioned a few times that you deposit into your Health Savings Account. Whether you do this passively, by an employer taking the money out of your check, or by actively depositing money from your bank account at the end of the day, the money does come out of your pocket. However, there is a maximum that you're able to deposit annually, as well as a maximum that can be carried over from year to year.
The maximum you can annually deposit into your HSA varies depending on your age and marital status/family status. In other words, if you're young and single with no children, you won't be able to deposit as much annually as someone who has children and is married. This is because Health Savings Accounts are designed to be a one-account solution, and theoretically, you should only need one per family. In 2021 an individual can contribute up to $3,600, and a family can contribute up to $7,200 annually to their HSA.
While rollovers are allowed, they do come with some stipulations. The main thing to remember about a rollover is that you're only allowed one per tax year. There are essentially two types of rollovers, the passive rollover in which money is rolled from one year to the next in the same account and the HSA transfer. In an HSA transfer, you roll your old account's balance into a new account. This may be done because of a job change. It should also be noted that once you begin a rollover, you must deposit the funds into your new HSA within 60 days, or you risk a tax penalty of 20%. I advise clients to take a direct rollover and NEVER put the money into your bank account!
Non-Medical Expenses and Your HSA
Now that we've talked about what is and what isn't a qualifying medical expense and how qualifying medical expenses are tax-free, we now need to talk about non-medical expenses. Your HSAs funds may be withdrawn at any time and used for… well, whatever you'd like, it's your money. However, once you withdraw money, it is no longer tax-advantaged. In other words, the IRS doesn't want you contributing money into an HSA (tax-advantaged) only to take it out, use that money however you please, and not pay taxes,
If you take out money from your HSA for non-medical reasons, a few things will happen. For starters, you'll now potentially owe taxes. However, if you're under the age of 65, you'll also likely receive a penalty. This means that you'll owe a 20% tax on whatever you've taken out in addition to having to pay regular taxes on that money. This can be avoided if you're over 65 or are disabled.
A CERTIFIED FINANCIAL PLANNER™ Can Help You Decide if a Health Savings Account is Right for You
There it is. A Health Savings Account laid out and thoroughly as possible. However, even though there's a ton of information about HSAs, what they are, how they work, as well as their advantages and disadvantages, you may still need guidance. When contemplating opening this account or that account, it's always best to talk to a financial professional, like a financial planner or financial coach. Those who work in the field will help you make tough decisions on what will and won't work best for you.
So… if you're considering an HSA but are feeling stuck, please call or email to schedule an appointment with me. I'll work with you to create a customized financial plan that's optimized for you.
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.