What is a Health Savings Account? Understanding the Purpose of an HSA

Open enrollment for your company is about to begin and you’re considering enrolling in a high-deductible health plan. Or you know that you will have health expenses in the future and you're looking for a way to pay for those costs without having to pay all at once. If you enroll in a high-deductible health plan and you have money to save for future health care expenses, opening a health savings account (HSA) allows you to save money on taxes and help pay for health costs when they come along. The National Association of Insurance Commissioners (NAIC) has information on how an HSA can benefit you.

TOP CONSIDERATIONS

How a health savings account (HSA) works. An HSA is a type of savings account that allows you to set aside money on a pre-tax basis to pay for qualified medical expenses. The untaxed dollars that you or your employer put in your HSA allow you to pay for deductibles, copayments, coinsurance and other expenses. Without the HSA, you would have to pay taxes on your earnings, then pay for your health care costs with what you have left.  By avoiding some taxes you would otherwise owe and letting your savings grow tax-free over time, you may be able to lower your overall spending.   

To contribute to an HSA, you must be enrolled in a high-deductible health plan.  For HSA purposes, a high-deductible health plan is one with a deductible of at least $1,400 for an individual or $2,800 for a family.  This means you pay at least $1,400 (or $2,800) out-of-pocket in a year before the health plan starts paying for its share of health costs.  Look for plans that say ‘HSA-eligible.’  If paying a high deductible doesn’t fit in your budget, an HSA may not be for you.

Contributions are limited and adjusted annually by the IRS. You can only add so much to your HSA in a year.  The annual limits for HSA contributions (for 2020, as indexed) are $3,550 for individuals and $7,100 for families. It's important to keep that in mind when deciding how much to put into your HSA. Individuals 55 and older can participate in what's called 'catch-up contributions'. They can add an additional $1,000 to their HSA in 2020.

QUICK FACTS

• HSAs can help consumers with high-deductible health insurance plans cover their out-of-pocket costs.
• Money unspent in an HSA rolls over at the end of the year, so it can be used for future medical expenses.
• The money belongs to you, so as you change jobs or insurance plans, your funds remain in your account.
• Most HSAs issue a debit card to pay for your prescription medications, co-pays and other eligible expenses. If you receive a medical bill in the mail, you can call the billing center and make a payment over the phone using your HSA debit card.
• With HSAs, funds stored in the account can grow tax-free for years and may be stored in an investment fund.
• Some HSAs charge a monthly maintenance fee or per-transaction fee. It can vary by employer or institution. The fees are not high but can cut into your bottom line. These fees can be waived if you maintain a certain balance.

Differences between a Health Savings Account and Flexible Spending Account:

A Flexible Spending Account (FSA) is another type of account that allows you to contribute before taxes are taken out. Like an HSA, it can be used to pay for eligible health expenses. However, an FSA is owned by the employer and is less flexible—the funds are intended to be used in a single year, rather than held over time. The maximum amount an employee can save in an FSA in 2020 is $2,750. You must spend the money in an FSA by the end of the year or specified grace period. Unlike an HSA, if an employee leaves a job, they can't take the FSA account with them.

HOW TO PROTECT YOURSELF

There could be taxes and penalties for early withdrawals. If you ever need to withdraw funds from your HSA for non-qualified expenses before you turn 65, you will owe taxes on the money. There is also a 20% penalty. After you turn 65, you will owe the taxes but not the penalty.

Keep a record of your transactions. Always keep your receipts for your HSA transactions. The receipts will prove that your withdrawals were used for qualified medical expenses.

THREE THINGS TO REMEMBER

Be sure and know what your insurance needs are and work toward your HSA requirements from there.

Health care consumers enrolled in a high-deductible health care plan are eligible to contribute to an HSA. They might not be the best option for patients who don’t want a high deductible plan or don’t have extra funds to save in the HSA.

HSAs aren't subject to federal income tax, so the earnings in the account grow tax-free.