Pros and Cons of a Health Savings Account
By Kevin Estes
Open Enrollment HSA
It’s fall and you know what that means. It’s open enrollment season!
With open enrollment comes questions about the Health Savings Account, or HSA.
What is a Health Savings Account?
An HSA is a tax-advantaged way to save money for qualified medical expenses. Funds can be invested an grow for the future.
The key word in Health Savings Account is savings.
Healthcare Flexible Spending Account (FSA)
With a healthcare Flexible Spending Account - or FSA - someone might lose unused funds at the end of the year.
At the end of 2023, only $610 can be carried over to the next year with a healthcare FSA.
It’d likely make sense for someone about to lose funds to pay for qualifying medical expenses before year end! HINT HINT!
Health Reimbursement Arrangement (HRA)
Employees might also lose funds in a Health Reimbursement Arrangement (HRA) account.
Employers may cap how much an employee can carry over from year to year. Balances above that limit may be lost forever.
Employers might also decide employees forfeit unused HRA funds when they leave the company.
Health Savings Accounts Are Portable
Unlike a healthcare Flexible Spending Account (FSA) and a Health Reimbursement Account (HRA), a Health Savings Account (HSA) is portable.
An HSA isn’t use it or lose it!
Someone who leaves an employer can take their Health Savings Account with them instead of losing it in a corporate version of Finders, Keepers.
The funds could also be used right away to pay for qualified medical expenses, though that often isn’t the best move.
HSA Triple Tax Advantage
The biggest advantage of a Health Savings Account is its triple tax advantage. It:
avoids taxes on the front-end,
grows tax-free, and
can be withdrawn tax-free if used for qualified medical expenses.
That is, it might olé the taxman altogether!
Biggest Drawback: High Deductible Health Plan
The biggest drawback is that to contribute to an HSA, someone needs to be on a High Deductible Health Plan - or HDHP.
How much someone must pay out of pocket before the insurance company pays anything – the deductible – is at least:
$1,500 for an individual and
$3,000 for a family.
Fortunately, there’s a maximum of:
$7,500 for individuals and
$15,000 for a family.
However, someone’s out of pocket medical expenses could be quite high with a high deductible plan. It’s a risk.
First, Evaluate the HDHP
It’s important not to let the tax tail wag the health insurance dog.
If the High Deductible Health Plan is the right call without the tax benefits, sign up!
Then consider contributing to a Health Savings Account.
2023 HSA Contribution Limits
The most that can be contributed to an HSA in 2023 is:
$3,850 for an individual or
$7,750 for a family.
That doesn’t seem like much until you consider the average American only saves about $5,000 a year – total.
Those age 55 and wiser can contribute an extra $1,000 with a catch-up contribution.
However, once someone goes on Medicare, they can no longer contribute to a Health Savings Account.
It’s Uncle Sam’s way of saying:
I want YOU to save EARLY.
Last Month Rule
There’s also a sweet “last month rule” for Health Savings Accounts.
In most cases, if someone is on a qualifying high deductible plan by December 1st, they can make the full-year HSA contribution.
Someone who goes on a qualifying plan in November can contribute the full:
$3,850 on individual or
$7,750 on family coverage.
However, there’s a catch.
They would need to stay on the high deductible plan for over a year - specifically through December 31st of the following year.
If they were to leave the plan before then, they’d have to pay income taxes PLUS a 10% penalty.
Qualified Medical Expenses for HSAs
Qualified medical expenses need to be for the:
insured individual,
their spouse, or
their dependents.
Fortunately, the list of qualifying medical expenses is as long as a Christmas list and includes:
preventative care,
insurance premiums, and
ongoing expenses.
Preventative Care
Covered preventative care expenses include:
physical exams,
immunizations,
tobacco cessation,
weight loss programs, and
screening services for cancer, heart disease, mental health, vision, and hearing disorders.
Ah, the joys of aging.
Insurance Premiums
Covered insurance premiums include long term care insurance premiums and healthcare premiums when:
unemployed,
on COBRA, or
on Medicare.
Let's run that back.
Even though someone can no longer contribute to an HSA once they go on Medicare, they can use the HSA funds to pay Medicare premiums.
Ongoing Expenses
There's also a whole host of covered care expenses:
prescription drugs,
dental treatments,
chiropractic, and
physical / speech therapy.
Also covered are pregnancy tests, infertility treatments, and - in case somebody wants to go the other way - birth control and vasectomies.
Reduces Payroll Taxes
Another tax benefit is that unlike most retirement plan contributions, contributions to a Health Savings Account reduce payroll taxes.
They're not subject to:
Medicare,
Social Security, and
federal unemployment tax.
No Income Limits
Health Savings Accounts also don't have an income limit like IRAs do, making HSAs popular with higher income taxpayers.
There's not even a requirement to have earned income to contribute to an HSA. Someone who has only investment income - such as an early retiree - might reduce their tax bill by contributing to a Health Savings Account.
Adult Child HSA
The Affordable Care Act enabled children to remain on their parents insurance until they turn 26. Someone can't be a dependent of another taxpayer and contribute to a Health Savings Account.
However, an adult child who's moved out of the basement and works full time might no longer be a dependent.
The parents may be able to contribute $9,750 to their Health Savings Account:
$7,750 family contribution +
each of their $1,000 catch-ups
The adult child, technically an independent taxpayer on a qualifying family High Deductible Health Plan, may also be able to contribute $7,750 to their Health Savings Account.
The parents might even make the contribution for their independent adult child, lowering the child’s taxes while helping them save for the future.
Heath Savings Account Downsides
We already explored the biggest downside of a Health Savings Account, the high deductible.
Contributing to an HSA also reduces how much cash is available for everything else. If funding's needed for ongoing expenses or to pay down high interest debt, contributing may not make sense.
None of this is financial advice, but pay your bills.
Keeping the lights on takes priority!
May Not Be Appropriate for Lower Tax Brackets
Contributing to a Health Savings Account may not be appropriate for those in lower tax brackets.
The cost of locking the money up for years or decades may be higher than the tax savings.
May Not Be Appropriate for Lower Tax Brackets
Another drawback is that whatever an employer adds to an HSA reduces how much the employee can contribute.
Mike is a single 27 year old.
His employer added $1,000 to his HSA.
The most he can contribute to the plan in 2023 is therefore $2,850 ($3,850 - $1,000).
It's an HSA teeter totter. That's not how it works for retirement plans, where employer contributions generally don't limit employee contributions.
Check Other Employer Plans
It's worth checking the employer contribution to the other healthcare plans.
A Flexible Spending Account (FSA) or Health Reimbursement Arrangement (HRA) might receive more employer contributions. After all, corporate might keep the leftovers!
I often suggest people catch money when it's thrown at them.
Possible Limits for Highly Compensated Employees
Some employers also have a history which limits how much high income employees can contribute to a Health Savings Account.
There are tests to ensure highly compensated employees aren't the only ones who benefit from these plans.
High Deductible Plan Only
Finally, if someone has a High Deductible Health Plan, they generally can't have any other health coverage and contribute to a Health Savings Account.
This is more of an issue for dual income couples, who each have health care coverage through work.
HSA Not Like a Retirement Plan
A Health Savings Account doesn't work quite like a retirement plan.
Employer contributions typically don't reduce employee contributions with a 401(k), like they do with an HSA.
The minimum age for catch up contributions is 50 for a 401(k), and 55 for an HSA.
Instead of a 10% penalty for non qualified withdrawals with a 401(k), it's 20% for a Health Savings Account...
and instead of being waived at age 59.5, as with the 401(k), the golden age is 65 for an HSA.
Typically, all funds in a 401(k) can be invested. However, HSA custodians often require a minimum amount of cash, such as $2,000. Funds in cash also often receive limited interest.
Finally, someone on Medicare can continue to save into a 401(k). However, that's not the case for an HSA: Uncle Sam cuts us off.
Can Wait to Submit for Reimbursement
A neat feature of the Health Savings Account is that someone doesn't have to submit for reimbursements right away.
They can instead save their detailed receipts in a safe digital place and then submit them as needed.
Withdrawing money from an HSA is a bit like taking contributions out of a Roth IRA. Just because it CAN be done doesn't mean it SHOULD.
Instead, someone could pay for those expenses out of pocket and let the HSA investments grow tax free for decades.
That said, it's nice to have those receipts handy should the need arise!
Hope This Helps
I hope this helps for you to better understand HSAs before your open enrollment deadline.
This article leveraged IRS Publication 969. It’s a great resource if you’re looking to explore further!
If you’d like a review of whether a Health Savings Account is appropriate for your situation, please…
Disclaimer
In addition to the usual disclaimers, neither this post nor this video includes any financial, tax, or legal advice.