Health Savings Accounts: Everything You Need to Know to Make the Most of Your HSA.
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What Is A Health Savings Account?
A Health Savings Account (HSA) is a tax-advantaged account where you can set aside money pre-tax earmarked for medical expenses. By using untaxed money from an HSA to pay for qualified medical expenses (such as deductibles, copayments, procedures, prescription drugs, etc.) you can afford medical expenses using tax-efficient strategies to lower your overall health care costs. Additionally, the money you contribute to your HSA and keep in the account can be invested and, over time, continue to grow year after year if you do not spend it. As the HSA funds continue to grow and accrue interest, with a smart investment strategy, you could have an HSA with a lot more money than you originally invested.
Therefore, HSAs are commonly referred to as being triple tax-advantaged:
Contributions made to an HSA are tax-deductible,
Funds can be invested in an HSA and grow tax-deferred, and
Distributions from an HSA to pay for qualified medical expenses are excluded from income and can therefore be used tax-free.
HSAs Are Triple Tax-Advantaged!
The value and advantages of this account are felt most strongly over extended periods. Younger individuals who are less likely to incur high medical costs may choose to establish an HSA and accumulate funds. As the individual gets older and more medical services are needed, the health care fund they built in the HSA will allow them to pay those bills pre-tax rather than out of pocket.
HSAs are also portable accounts, meaning if you change jobs, you do not have to lose access to the funds or spend them all – they can follow you after you leave your employer. In addition, you can have an HSA through your employer (if they offer one) and hold a separate pre-existing one that you manage on your own. Be careful though of the contribution limits. Just because you have separate HSAs does not mean you can cumulatively contribute more than the allowable amount annually.
Between the tax advantages, easy access to funds, and growth potential of the funds within the account, HSAs can be an effective and powerful tool in crafting your financial plan.
How Does A Health Savings Account (HSA) Differ From A Flexible Spending Account (FSA)?
Despite their similar names and purposes, HSAs and FSAs each have their advantages and disadvantages. To start, while the acronyms are similar, the full names spell a big difference between the two – Health Savings Accounts are for saving; Flexible Spending Accounts are for spending. In other words, HSAs are designed to be a tax-advantaged savings tool to help pay for medical expenses, whereas FSAs allow you to set aside money pre-tax to help meet annual eligible costs. As mentioned, HSAs are triple tax-advantaged, while FSAs are only double. This means that HSAs have the added bonus of investing funds and securing tax-deferred growth, whereas you cannot invest funds in an FSA – the funds are supposed to be spent.
Traditionally, the FSA has had a ‘use-it-or-lose-it’ policy, meaning if any money at the end of the year is left in your FSA, you lose those funds. However, in 2021, the U.S. Treasury Department amended this to allow plan participants to roll over some funds to the following year. Under the new regulations, employers can either:
Enable up to $610 of unused funds in an FSA to be carried forward from the previous year into the following year, or
Allow plan participants a grace period of two and a half months to use the funds or lose them.
HSAs and FSAs also have their own contribution limits. The annual maximum contribution to an FSA changes each year, but for 2023 it is $3,050. HSA contribution limits also vary each year but are slightly different from FSAs in that it depends on whether your health insurance plan only covers you as an individual or if you are covered under a family plan. If the coverage is just for you (self-coverage), your contribution limit for 2023 is $3,850 (and $4,150 in 2024). If you have family coverage, the maximum contribution to an HSA for 2023 is $7,750 (and $8,300 in 2024). More on this is below.
FSAs work with any employer-sponsored health plan, whereas HSAs require a specific type of health plan to allow for an HSA. Therefore, you must be an employee to qualify for an FSA; self-employed or unemployed individuals cannot open an FSA. HSAs, on the other hand, do not have to be offered through an employer. Therefore, if you meet the other eligibility requirements, anyone can set up an HSA. We’ll discuss eligibility requirements in more detail in the next section.
Finally, HSAs are portable, meaning you can still access the funds and bring them with you if you leave your employer. That is not the case, however, with FSAs. Since FSAs are tied to an employer-sponsored plan, you must spend the funds or forfeit them if you leave that employer.
Am I Eligible?
There are a few things to know to ensure that you are eligible to establish and start funding an HSA:
You must be covered under a high-deductible health plan (HDHP) and cannot be covered simultaneously under a different health plan.
You are not claimed as a dependent on someone else’s tax return.
To qualify for an HSA, you must be covered under a specific type of health insurance plan. HSAs are only compatible with a high deductible health plan (HDHP). An HDHP is just like it sounds, a health insurance plan with a higher deductible limit than your average base health insurance plan. Consequently, most of the burden of paying upfront expenses falls on the individual. An HDHP primarily covers only preventative services (such as a routine physical or some bloodwork) before meeting your deductible. Because of this, you can only contribute to an HSA when enrolled in an HDHP with no other coverage. In other words, if you are covered under an HDHP and another health plan, this could disqualify you from making contributions.
However, not all HDHPs are necessarily compatible with an HSA. Under tax law, HDHPs that are HSA-eligible set a minimum deductible and out-of-pocket maximum. These amounts are set by the IRS and change annually based on inflation. For 2023, these amounts are:
Minimum Deductible & Max Out-of-Pocket Costs for HDHPs (2023)
For the plan year 2023, the minimum deductible for an HDHP is $1,500 for an individual and $3,000 for a family plan. When checking the available options for HDHPs in your employee benefits, double-check that the plan is HSA-eligible. The same applies when shopping for plans on the Health Insurance Marketplace®, Small Business Health Options Program (SHOP), or healthcare.gov.
When shopping for a health plan on the healthcare.gov marketplace, be sure to check off the box “Eligible for a Health Savings Account.” This will filter out all the plans that are not eligible and leave you with the ones that are.
Some health insurance companies offer HSAs for their HDHPs, but you do not have to establish the HSA through the health plan provider. You can instead open one through a qualified HSA Administrator such as a bank, brokerage firm, or other financial institution. Also, if your employer offers HSA-eligible plans, your human resources department should have information on the HSA Administrator they use.
If your family is covered under an HDHP, each spouse must open a separate HSA to contribute. You cannot have a joint HSA account.
Do HSAs Have Income Limits?
Nope! HSAs do not have income limits, so on that basis, anyone can use one and get the tax benefits.
What If I Enrolled In Medicare Part A While Still Working And Keep My Company-Sponsored HDHP? Can I Still Contribute To An HSA?
Unfortunately, HSAs are not compatible with Medicare coverage or any plan that pays its share of costs without you having to pay deductibles or copayments first (called “first dollar coverage”). In other words, HSAs are only compatible with HDHPs, no other health plan.
In fact, you should stop contributing to an HSA six months before you switch to Medicare (or starting Social Security, which automatically enrolls you in Medicare at age 65). Medicare has a six-month lookback period when you sign up, even if you were covered under private insurance during that time, leaving you liable to pay six months’ worth of tax penalties on your HSA contributions. If you make contributions within that six-month window, you can withdraw the contributions before the end of the year without penalty.
This does not mean you must use or lose the funds once covered under Medicare. Instead, once you are covered under Medicare, you cannot set up and/or make contributions to an HSA (or receive employer contributions), but you can continue to spend the funds if you had set up and funded the HSA prior to enrolling in Medicare. Therefore, your HSA funds can be available tax-free so long as they are used for qualified medical expenses – which includes Medicare premiums and deductibles for Parts B, C, and D, but excluding premiums on supplemental Medicare programs (Medigap).
Having an HSA during retirement becomes especially useful as you get older and medical costs become more expensive. Medicare or your supplemental insurance may not cover all of your expenses, so drawing upon your HSA can be a great way to pay for those expenses to bring down your overall cost of care.
How Do I Use An HSA?
To understand how best to use HSAs, let’s break it down into three parts:
How much can you contribute, and what are the contribution limits?
How does the savings component work?
How do withdrawals and account distributions work? And what can account funds be used for?
How Can I Contribute, And What Are The Contribution Limits?
Contributions to an HSA come in four types:
Payroll deductions. Money gets automatically deducted from your paycheck every month, giving you an immediate tax benefit,
Employer contributions. These contributions your employer makes to your HSA are not taxable. But be careful! There are limits to the amount you can annually contribute to an HSA, and this includes any employer contributions,
Individual (Recurring) Contributions. If you qualify for and establish an HSA on your own, you can manually transfer money from your bank account and take the tax deduction when you file your taxes later. It is probably a good idea to either do a lump-sum payment or to set up recurring transfers. If you choose to do continuing transfers, make sure you adjust the amount annually to keep up with the changing maximum contribution limits.
Third-Party Contributions. Anyone can contribute on your behalf to your HSA. Not only that, but you can deduct those contributions on your tax return regardless of whether the money you contributed was yours or someone else’s.
To take full advantage of the benefits of an HSA and to build a substantial reserve for the future, it is a good idea to try to save the maximum allowable amount each year.
These contribution limits change annually:
For 2023, you can contribute up to $3,850 if you have coverage as an individual (and $4,150 in 2024).
If you are covered under a family plan, you can contribute up to $7,750 (and $8,300 in 2024).
You can claim a tax deduction for the contributions you, or someone other than your employer, make to your HSA. Also, matching contributions made by your employer to your HSA can be excluded from your gross income.
If you are 55 or older, you can utilize a ‘catch-up’ provision to contribute an extra $1,000 to your HSA each year. If your spouse is also 55 or older, they can make the catch-up contribution to their HSA if eligible, but not to yours.
Limits on HSA Contributions (2023)
Annual HSA Contribution Limit
Annual HSA 'Catch-Up' Contribution
What Happens If I Contribute More Than The Annual Limit?
Any contributions above the annual limits are not tax deductible and are subject to a 6% excise tax on the excess amount. In addition, you will have to pay income taxes on any earnings on the excess.
If you make a mistake and contribute more in one year than what is allowable, you can do one of two things:
Before filing your federal income tax return, you can withdraw the excess amount and the income attributable to the excess contribution. You must report the amount removed from your HSA on your tax return and pay income taxes. In doing this, you will avoid paying the 6% excise tax.
You can leave the funds in the HSA and excess contributions could be counted as part of your contribution for the following year. The next year, you will want to ensure you are not making the same mistake again and factor in the excess amount into that year’s contribution.
What Is The Cut-Off Date To Make The Full Contribution For The Year?
If you become eligible for an HSA on or before the first day of the last month of your tax year (December 1st for most people), you can make the full annual contribution limit for that year even if you were not eligible for the entire year. This is called the ‘last month rule’ or the ‘full contribution rule.’ If you earn eligibility on December 2nd or later, you can only contribute a prorated amount.
Generally, you have until the tax filing deadline to make your contribution to your HSA, which for the tax year 2023 is April 15th, 2024. If you are unsure of the amount you can contribute in a given year, you can use an eligibility calculator (like this one) to help figure it out. Note, if you make a full contribution under the ‘last month rule,’ you must remain eligible for twelve months (i.e., December 1st, 2023, through December 31st, 2024). This is referred to as a ‘testing period.’ If you cannot remain eligible during the testing period (for reasons other than death or disability), you must include some of the amounts you contributed in your income and pay a 10% penalty.
How Does The Savings Component Work?
One of the considerable advantages of an HSA is that if you do not have enough eligible healthcare costs, you can save and invest funds in the account. Depending on the HSA Administrator and which investment firm you use for the HSA, your investment options may be limited. However, investing the funds can be especially worthwhile if your health costs are low and/or you do not plan on spending the funds. By investing funds in an HSA for the long term, fluctuations in the stock market will not impact your finances. However, if you need the funds in the short term, you may be better off keeping the money safe, either in a money market fund or in short-term debt instruments. It is a good idea to talk to a financial advisor (like us!) if you need help with how to invest your HSA funds.
What Can Account Funds Be Used For?
As mentioned earlier, there is no time limit as to when you need to use your HSA funds, and there is no ‘use-it-or-lose-it’ provision like with FSAs. As long as you use funds in your HSA to pay for ‘certain [qualified] medical expenses,’ the funds you withdraw will not be taxed. To use HSA funds, you can either use the debit card tied to your HSA or pay independently (via credit card, personal debit card, check, or cash) and submit it to the HSA provider for reimbursement. If you opt for reimbursement, you will usually have to provide a receipt to the HSA Administrator to prove the transaction was eligible.
What Do ‘Certain Medical Expenses’ Encompass?
Generally, the money you withdraw from the account is not taxed as long as you spend it on qualified, out-of-pocket medical costs, including (but not limited to):
Deductibles, copayments, and coinsurance,
Doctor and telehealth visits,
Imaging (MRIs, x-rays, etc.),
Medical services and some long-term care costs (such as home care),
Medical equipment or supplies,
Psychological therapy and psychiatric care,
Usually, insurance premiums are not considered qualified expenses. Also, you can use HSA funds to pay for qualified medical expenses for your spouse and dependents, even if they are not covered under your HDHP.
By extension, you can also spend the money on eligible dental and vision expenses, such as:
Deductibles, copayments, and coinsurance,
Fillings & crowns,
Non-cosmetic dentures and implants,
Prescription contact lenses and solution,
Eyeglasses and bifocals, and their cases and cleaning cloths,
Corrective sunglasses and swim goggles,
Dental or vision surgery.
However, HSAs cannot be used for ‘general health’ such as cosmetic products, like teeth whitening treatment, cosmetic dental procedures, mouthwash, toothbrushes, toothpaste, floss, etc. One exception is if a doctor or dentist deems a general health-related tool or service medically necessary to treat a specific illness or condition. In such circumstances, the provider can write a note or a prescription.
For more information about which expenses are eligible or not for HSA funds, contact your HSA Administrator. They may even have an online search tool like this.
Make sure you always keep your receipts regardless of whether you paid using HSA withdrawals or out-of-pocket. You will need them to show that your expenses are, in fact, qualified should you ever be audited, and it is your responsibility to maintain records of your medical costs and reimbursements.
TIP: To use an HSA as a highly effective wealth building tool, you can cover medical expenses out of pocket and let the HSA funds grow for the long term. In the meantime, keep your receipts in a safe place (i.e., in a folder, snap a picture and save them to your computer, etc.). At a later date, when there is more money in the account than when you incurred the expenses, you can pull out those receipts and reimburse yourself for those expenses completely tax free. This is possible because HSAs have a look-back provision. In other words, there is no time limit to when you need to file for reimbursement; the receipts can go back as far as the start of the account. If you do it right, you should never need to take a taxable distribution from your HSA. Just note that expenses incurred before establishing your HSA are not qualified, so you cannot use these funds for the look-back.
What Happens If I Use My Money To Pay For A Non-Qualified Expense?
If you use money from your HSA for non-medical costs or non-qualified medical expenses before you turn 65 years old, you will have to pay income taxes on that amount and a 20% tax penalty.
If you use money from your HSA for non-medical costs or non-qualified medical expenses after you turn 65 years old, you will not have to pay the 20% penalty, but you still have to pay income taxes on that amount. In other words, once you turn 65, you can use your HSA like a 401(k) or an IRA – it is for this reason that HSAs are nicknamed 'Stealth IRAs.' The difference, however, is that HSAs do not have mandatory distributions in retirement, also known as Required Minimum Distributions (RMDs).
What If I Am No Longer Covered Under A High Deductible Health Plan (HDHP)? Does The ‘Use-It-Or-Lose-It’ Rule Apply Then?
Once you deposit money into your HSA, you may use the funds to pay for qualified expenses tax-free. This applies even if you are no longer covered under an HDHP. However, just note that if you are no longer covered under an HDHP, you can no longer contribute to your HSA without being taxed. The ‘use-it-or-lose-it’ rule only applies to FSAs but not HSAs. That means the funds in your account will remain there year after year until used, even if you are no longer covered under an HDHP. There is no date by which you must spend these funds.
What Happens If The HSA Owner Dies?
First and foremost, you should always designate a beneficiary when you set up your HSA. With that being said:
If a spouse is the designated beneficiary, it will be transferred to the spouse and become the spouse’s HSA.
If a non-spouse is the designated beneficiary, the account will cease to be an HSA, and the value of the HSA becomes taxable to the beneficiary in the year in which the HSA owner died.
If the estate is listed as the beneficiary (or no beneficiary is designated), the value is included on the decedent’s final income tax return. In this situation, the amount taxable to the beneficiary can be reduced by any of the decedent’s qualified medical expenses paid by the beneficiary within one year after the date of death. In other words, the beneficiary has twelve months to take withdrawals for any overlooked medical expenses on the deceased account holder’s behalf.
Before deciding to get started with an HSA, it is essential to understand your current financial and medical situation. If you have sizeable healthcare costs, HSAs might not be a good idea because they will apply to your deductible, and you will be responsible for a significant amount of those costs. Also, if you need ongoing medical treatment or frequent specialist visits, the amounts for those visits can add up quickly. In these situations, having a high-quality health plan and supplementing your out-of-pocket costs with a flexible spending account (if you have one) may be more prudent. However, if you are young and healthy and looking for an additional savings fund, a health savings account might be the way to go, as it can be immensely beneficial for achieving your financial goals. HSAs are also a great tool to complement your retirement plan.
In short, the secrets to using an HSA for wealth building are:
Contribute as much as you can (ideally the annual IRS limit) each year,
If you can, pay for medical expenses with other funds; otherwise, only touch the funds for emergencies,
Invest the untouched funds for growth and let the profits accumulate, and
At a later date, utilize the look-back provision to draw from HSA dollars after you have let that money accumulate.
About the Author
Holzberg Wealth Management is a family-owned and operated financial planning and investment management firm based in Marin County, CA. As your financial advisors, we serve you as a fiduciary and are fee-only, so we never receive commissions of any kind. We help individuals and families like you in the greater San Francisco Bay Area and virtually nationwide with the financial decision-making process to organize, grow, and protect your assets.
** This writing is for informational purposes only. The author and Holzberg Wealth Management do not guarantee or otherwise promise any results that may be obtained from using this report. No reader should make any investment decision without first consulting their financial advisor and conducting their own research and due diligence. These commentaries, analyses, opinions, and recommendations represent the personal and subjective views of the author and do not constitute a recommendation, offer, or solicitation to make any securities transaction. The information provided in this report is obtained from sources that the author believes to be reliable. External links to third parties are being provided for informational purposes only. Holzberg Wealth Management is not affiliated with the third-party websites linked to, unless otherwise explicitly stated, and does not constitute an endorsement or approval by Holzberg Wealth Management of any of the third party’s products, services, or opinions.