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The Beginner’s Guide To Health Savings Accounts (HSAs)

What is an HSA? How do health savings accounts work? Who’s eligible? Eliminate your confusion about using HSAs with your health insurance plan.

How health savings accounts work.Health savings accounts (HSAs) are a vital part of many health insurance plans, but many of us don’t fully understand how HSAs work.

Lauren and I just switched to an HSA health insurance plan for next year and I have to admit — even as a financial blogger — I’ve been avoiding them for years because HSAs always seemed mysterious. Let’s fix that.

What is an HSA?

The easiest way to think of an HSA is like a 401(k) or IRA but for healthcare expenses rather than retirement expenses. Each year you can contribute pre-tax dollars into an HSA that can be used to pay for current or future medical expenses.

Is money I put into an HSA “use it or lose it”?

No. HSA dollars roll over, so anything you don’t spend this year will still be yours and will continue to grow tax-free.

If you withdraw money from an HSA for non-medical expenses, you will have to pay tax on the money and – if you’re under age 65 – you’ll have to pay a penalty of 20 percent, too. (This is just like early withdrawal penalties on a 401(k) or an IRA.)

Why do HSAs exist?

As high deductibles on health insurance plans began passing on a larger share of medical costs to consumers, the government created HSAs to provide a tax benefit to Americans who save for their own healthcare.

Without HSAs, medical expenses are not tax deductible unless they exceed 7.5 percent of your annual adjusted gross income (AGI) – a criteria that, in any given year, most of us (hopefully) don’t meet. With HSAs, however, money you invest in the HSA and later use for medical expenses is tax-free.

Who is eligible for an HSA?

To be eligible for an HSA you must carry what’s known as a high deductible health plan (HDHP). For 2013 and 2014, that means any health insurance plan that has an individual deductible of $1,250 or more for an individual or $2,500 for a family.

I don’t have health insurance through work, can I still get an HSA?

Yes. It doesn’t matter if you get the health insurance plan through your employer or on your own, you can still have an HSA.

If you get health insurance through work, however, your employer will likely administer the HSA and can withhold money from each paycheck. Some generous employers may even deposit money into your HSA for you, similar to a 401(k) match. And just like a 401(k), you can move your HSA if you ever leave your job.

If you’re searching for health insurance on your own you can find plans through a marketplace like eHealthInsurance.

How much can I contribute to an HSA?

In 2014, HSA contribution limits are $3,330 for an individual and $6,550 for a family (up slightly from 2013 limits of $3,250 and $6,450, respectively.) Participants 55 and older can make “catch-up” contributions up to an additional $1,000.

What can I buy with HSA dollars?

The IRS defines expenses that are eligible for medical deductions. You can use your HSA dollars for any virtually any medical expense including:

  • Prescription medications
  • Doctor’s visit co-pays
  • Surgeries
  • ER visits and hospital stays
  • Dental costs
  • Birth control
  • Mental health services

Some things you cannot use HSA dollars for include:

  • Nonprescription (over-the-counter) medications
  • Medications or treatments purchased outside the United States
  • Non-medically-necessary procedures like cosmetic surgery

The smart way to use your HSA

Before I took the time to learn about HSAs, I always thought of them the way most Americans use them. You contribute a few pre-tax dollars every paycheck and, when medical expenses arise, you either:

  1. Pay with them with a debit card tied to your HSA or
  2. Submit receipts for reimbursement at the end of the year

There’s nothing wrong with using your HSA that way for current-year medical expenses, but a smarter way to use an HSA may be to simply contribute as much as you can, invest it, and let it grow tax-free to be used for medical expenses in retirement.

There are a few reasons for investing HSA dollars long-term rather than using them this year.

  1. The longer you leave HSA dollars invested, the more the account’s tax-free status boosts the money you keep.
  2. Most of us will have more medical expenses in retirement, when we may be living on less income and/or be relying on Medicare for health insurance.
  3. After age 65, you can withdraw HSA dollars for any reason without paying a penalty. If used for non-medical expenses, you’ll have to pay income taxes on the withdrawal, but deferring those taxes while the money grows is still a significant benefit.

In summary, HSAs are another tool you can use to keep a bit more of your money rather than paying it to Uncle Sam.

If money is tight, contribute a little bit to your HSA to cover your estimated medical expenses this year (even if it’s only a couple hundred bucks in copays and prescriptions). If you can afford to save more, divert some dollars from taxable savings accounts to an HSA. And, if you’ve maxed out available retirement options, consider an HSA as a “back-door” way to put aside even more tax-deferred dollars for your future.

Published or updated on December 19, 2013

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.


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  1. Sara says:

    It’s useful to note that the earlier you open an account, the better! Once the account is open, it can be used for any healthcare expense incurred, but if you wait for something to happen, the money can not be used retroactively to cover expenses before the account was opened. For example, if you have an account balance of $300 just to keep the account open and you incur $1000 of medical expenses, you can add more money to the account and reimburse yourself later!

    I recently returned to grad school, but left enough money in my HSA account to cover monthly account fees for up to 10 years just to keep the account open. This way, any healthcare expenses that I incur while in school (even though I don’t currently have an HDHP plan) can still be reimbursed with money that I put in the account after I go back to work.

  2. Lucas says:

    Everything you mentioned looks correct (except that HSA withdraw penalty was changed from 10-20%), but there are two key points you skipped that are pretty crucial for most people in the PF community to understand.

    1) Money goes in completely tax free if part of a payroll deduction – that means you don’t pay social security or medicare expenses (this is an extra 8% boost over 401k/IRA). And as long as you use it for medical expenses it is tax free coming out.

    2) You can submit medical reimbursement claims for any past expenses occurred after you opened your HSA!! That this means is that you can just keep track of your significant medical expenses and then at any point (even 30 years) down the road you can pull all of that money out completely tax and penalty free!!! This offers a great potential for anyone considering retirement before 59 1/2.

    These two points combined make HSAs probably the best option for retirement savings after getting your full 401k Match. The only downside a lot of times is that the investment options in most HSA offered through companies have higher fees then ideal (closer to 1%). Fortunately you can roll your money into another HSA whenever you want. There is usually a small fee to do this ~$30 or so, so you would probably build up a small balance before it is necessary. ( HSA offers access to vanguard index funds).

    • David Weliver says:

      Excellent additions, Lucas, thank you. I’ve corrected the penalty figure in the article — you’re correct it increased from 10 to 20 percent as a result of the Affordable Care Act.

      • Lucas says:

        Thanks :-) Always learning stuff! It actually makes sense why they increased the penalty. Because at 10% it was basically equal to the savings you got from lack of social security and medicare taxes so there was no deterrent from putting money in and then pulling it right back out. If you were self employed you could actual gain money that way as you would save ~17% self employment social security and medicare taxes, then only pay 10% penalty (pretty sure it worked that way).

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