What Is a Health Savings Account and Do I Need One?

A health savings account (HSA) offers significant tax advantages for employees and self-employed individuals.

Health savings accounts (HSAs) are intended to help people save money for health care expenses. They offer significant tax advantages, but they aren’t available to everyone: You may open an HSA only if you have a high-deductible health plan and meet other eligibility requirements. Read on to learn what an HSA is, who can open an HSA, rules for depositing and withdrawing money from your account, and more.

How Health Savings Accounts Work

An HSA is a special kind of savings account you can use to pay health care costs. You deposit pre-tax money into an HSA; if you are employed, your employer may also deposit money into your account as an employment benefit. If your account increases in value—because it’s invested or earns interest, for example—those earnings are not taxed. And, as long as you withdraw money from the account only to pay for qualified medical expenses, you don’t have to pay tax on withdrawals, either. In other words, an HSA allows you to pay certain medical expenses with tax-free money.

An HSA is different from an FSA for medical expenses, which is an employer-sponsored benefit plan. To learn more about this topic, see our article on FSA plans.

Who Can Open an HSA?

You can open an HSA whether you work for an employer or are self-employed. To qualify, you must meet all of these requirements:

  • You may not be enrolled in Medicare.
  • You may not be claimed as a dependent on someone else’s tax return.
  • You must be covered by a high-deductible health plan (HDHP). An HDHP must have a deductible of at least $1,350 for an individual plan or $2,700 for a family plan. (These minimums are for 2018; the amounts are adjusted each year.) And, the plan must limit out-of-pocket expenses to no more than $6,650 for an individual plan or $13,300 for family coverage, in 2018.
  • You may not be covered by any other health insurance plan. Exceptions are made for certain limited policies, such as vision or dental insurance, disability insurance, and workers’ compensation coverage.

An HSA is not a regular bank account. You must open your account with a qualified HSA trustee, like an insurance company or a bank, that the IRS has approved for this purpose.

Contributions to an HSA

Because of the substantial tax savings HSAs offer, there are annual limits on how much you may contribute to your account. These amounts are adjusted every year. For 2018, you may contribute up to $3,450 to an individual account or up to $6,900 to a family account.

These limits are the total amount that may be contributed to your HSA account by anyone, including your employer. In other words, if your employer contributes $100 a month to your HSA account for individual coverage, you may contribute only $2,250 to your account.

Using the Money in Your HSA

If you have an HDHP, your plan generally won’t pay your medical expenses until you have met your deductible. That’s where the HSA comes in: It gives you a way to save that money, tax-free, to use for these expenses.

You can request a distribution (essentially, a withdrawal) from your HSA to pay qualified medical expenses, or to be reimbursed for them if you’ve already paid. Qualified medical expenses are any expense you could deduct on your tax return. These expenses include the costs of health care, dental care, and vision care, as well as a range of other products and services, from prescription drugs and nursing care to psychotherapy and smoking cessation programs. However, you can’t pay your premiums for your HDHP out of your HSA funds. (See IRS Publication 502: Medical and Dental Expenses, for a full list of eligible expenses.)

You don’t have to pay these expenses out of your HSA. In fact, you don’t have to take any money out of your HSA from year to year. Your HSA can continue to accumulate (and earn) money, until you need it.

If you take money out for any reason other than to pay qualified medical expenses, you’ll have to pay tax on the withdrawal. If you are not yet 65 years old, you will also have to pay a 20% penalty; the penalty doesn’t apply if you are 65 or older.

If You Leave Your Job

Unlike other types of employment-based accounts, like a 401k or a flexible savings account (FSA), an HSA is yours and stays in your name. You don’t have to roll it over if you are fired, quit, or retire from your job. Even if you go work for a different employer, you keep your same HSA.

Should You Open an HSA?

If you have a HDHP and meet the other eligibility requirements, opening an HSA can save you a lot of money. These accounts offer tax savings on contributions, earnings, and withdrawals, which means you can save money tax-free for medical expenses. And, because you don’t have to spend this money down annually (as you might for other types of accounts, such as FSAs), you can build up a significant cushion against medical expenses later in life, even after you retire. Especially if your employer offers a match or otherwise contributes to your HSA, you can use the account to sock money away for a medical rainy day.

The more difficult question is whether to use an HDHP for your health care coverage in the first place or, instead, get a (typically more expensive) plan with a lower deductible. Only you can decide, based on your health status and finances, what type of plan makes sense. But if you have an HDHP, opening an HSA to help you save money for medical expenses can make great financial sense.

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