What is a health savings account?
Health savings accounts (HSAs) are tax-advantaged savings and investment accounts available to people with high-deductible health plans. You can set aside money in an HSA, free of federal taxes, to pay for qualified medical expenses. Money saved or invested in an HSA also grows federal-tax-free. And as long as you spend the money on qualified medical expenses—such as doctor visits, prescription medications, eye exams and dental care—withdrawals aren’t taxed, either.
Why do they exist?
HSAs were created in 2003 to give people with high-deductible health plans a tax break, as many employer-sponsored health plans have shifted more of the responsibility of paying for health care to individuals.
As many as 22 million people now participate in an HSA, and some 72% of employers with more than 500 employees look set to offer these accounts by 2019. That’s up from less than a quarter in 2010.¹
Who can open an HSA?
You are eligible to enroll in an HSA if:
- you’re enrolled in a high-deductible health plan;
- you aren’t covered by another health plan that’s not high-deductible (for instance, a spouse’s plan);
- you aren’t enrolled in Medicare; and
- you can’t be claimed as a dependent on someone else’s tax return.
As the name implies, high-deductible health plans have higher-than-average deductibles. For 2017, the IRS defines them as requiring annual out-of-pocket payments of $1,300 for an individual plan, and $2,600 for a family plan, among other requirements. You can find more details about HSA requirements in IRS Publication 969.
How do I contribute?
If your employer offers a high-deductible health plan, it may also direct you toward an HSA (some employers even make annual contributions to their employees’ HSA accounts). You can also open an account on your own through a qualified HSA provider, such as a bank or insurance company.
Both you and your employer can contribute to an HSA up to annual limits:
You can make your annual contribution right up to the federal tax filing deadline for that year—for instance, for the 2016 tax year, you have until April 18, 2017, to contribute to your HSA.
However, note that you can’t contribute to an HSA if you’re enrolled in Medicare. If you’re 65 or older and file for Social Security benefits, you’ll automatically be enrolled in Medicare Part A. You should stop making HSA contributions six months prior to filing for Social Security, if you are claiming benefits after age 65.
Can I invest HSA balances?
Funds in an HSA account can be invested, although the investment choices will vary depending on the HSA administrator. Some HSAs have limited options, such as a bank savings account. Others may offer a range of products, including mutual funds or exchange-traded funds. Note that many plans require a minimum balance—for instance, $1,000 or $2,000—before you can make investments.
As a practical matter, it’s a good idea to keep HSA funds needed to pay for two to three years of potential out-of-pocket healthcare expenses in cash or a cash investment, such as a bank deposit account—for instance, a checking or savings account—or a money market fund. Keeping a portion of your funds in a relatively stable, liquid investment can help you avoid being forced to sell riskier investments in a down market to fund an unexpected medical bill.
Also, you should never put off seeing a doctor because you don’t want to spend the funds in your HSA. Potential investment growth may be nice, but you won’t enjoy your earnings much if you’re sick.
What if I change jobs?
Your HSA is portable—if you change jobs, you can take it with you. Also, if you die with money still in your account, you can leave it to your spouse (who can use the money free of estate taxes, and tax-free for non-medical expenses) or other heirs (who would pay taxes on the money they inherit).
What is a qualified medical expense?
Doctor visits, diagnostic tests and laboratory fees, prescription medication, eye and dental exams, psychiatric care and many other types of expenses are considered qualified expenses. See IRS Publication 502 for a complete list of qualified expenses.
What is the “triple tax benefit” of an HSA?
As mentioned above, HSAs offer account holders a triple tax exemption:
- no federal income taxes on contributions2
- no federal taxes on investment earnings3
- no taxes on withdrawals for qualified medical expenses
By comparison, 401(k) retirement plans offer just a double tax benefit—you pay no income taxes on contributions and no tax on investment earnings, but you do pay taxes on distributions in retirement. That triple exemption can make HSAs a uniquely powerful tool for building a nest egg for future health care expenses.
However, note that if you’re under 65 and you spend money from your HSA on non-qualified expenses, you’ll have to pay ordinary income tax on your withdrawals—plus a 20% penalty. After age 65, you’ll just have to pay income taxes.
HSA vs. FSA: What’s the difference?
Both an HSA and a health care flexible spending account (FSA) let you set aside pre-tax dollars to pay for future health care expenses. However, there are some key differences:
- There are no special eligibility requirements for an FSA.
- If you don’t use the total amount contributed to an FSA during a calendar year, you may lose it. Although your employer may allow you to carry over $500, or give you a grace period in which to spend unused funds, this isn’t required.
- You can’t take an FSA with you if you change jobs, and any unused funds may have to be forfeited.
1 Paul Fronstin, "Health Savings Account Balances, Contributions, Distributions, and Other Vital Statistics, 2015: Estimates from the EBRI HSA Database," Employee Benefit Research Institute, 11/29/2016.
2 HSA contributions are not deductible in several states, including California, Alabama and New Jersey. Check with your tax advisor for specific tax advice.
3 State taxes may vary.