Choosing the right health insurance impacts your physical and financial well-being. Because of its importance, you’ll want to seriously consider the finer points of coverage, such as which providers you have access to or the plan’s cost.
However, as health insurance has become more accessible through the ACA marketplace, medical costs have also increased. Experts expect medical costs to increase in 2022 alone by 2-5%. As a result, many insured people seeking coverage may find that monthly health insurance policy premiums may increase further.
For those in this situation, there may be a solution in high-deductible health plans (HDHP). These plans have a higher deductible than an average plan but lower premiums. If you have an HDHP, you can save for the deductible and enjoy tax benefits with a health savings account (HSA). HSAs allow insurance customers to add money to a savings account pretax to cover copays, OTC drugs, prescriptions, and more while saving money.
Curious to see if an HSA is right for you? Read on to learn more.
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What Is an HSA?
A health savings account helps you save for medical expenses with pretax dollars. These medical expenses may include the following:
- Copays (prescriptions and doctors visits)
- Medical Supplies (Wheelchairs, Crutches, Hearing Aides)
- Family Planning Supplies
- Covid-19 Supplies
- Pregnancy and Childcare Supplies
- Medical Procedures (CT Scans, X-Rays)
- Medical Transportation
- Urgent Care Services.
While this is by no mean a complete list of the services and products one can pay for with HSA, the list shows that the account is versatile and provides support for people with a wide array of medical needs.
HSAs also offer pretax savings advantages. For example, if your contribution to the HSA reduces your taxable income, and you earn $50,000 and contribute $2,000 to an HSA, you pay taxes on $48,000 rather than your total salary.
To open an HSA, you generally need a high-deductible health plan (HDHP). The IRS defines an HDHP as having a deductible of $1,400 or more for an individual or $2,800 or more for a family. The maximum out-of-pocket cost is $7,050 for an individual and $14,100 for families.
How Does An HSA Work?
If your employer offers an HDHP, it likely offers an HSA. You’ll sign up during open enrollment and make deposits by payroll deduction. If your employer does not offer an HDHP, or their HDHP does not offer an HSA, you should research providers and set up an HSA at a financial institution. Make sure to compare how the HSA providers handle deposits and see if fees are associated with the account.
The government sets limits on what you can contribute to an HSA. In 2022, the limit is $3,650 for an individual and $7,300 for a family. If you’re 55 or older by the end of the year, you can contribute “catch-up” contributions of an extra $1,000. Each year, you’ll decide how much to deposit to the HSA account, up to the limits set by the IRS.
As noted above, the amount you contribute reduces your taxable income. When you deposit contributions directly to an HSA account, your contributions are tax-deductible. If your employer contributes to your HSA, that amount is not deductible.
Most HSAs give you a debit card or checkbook to pay for health expenses. You can use your HSA to pay for qualified medical expenses, including deductibles, copayments, and coinsurance.
How To Qualify For an HSA
The Internal Revenue Service (IRS) establishes standards to qualify for an HSA. Here are the eligibility requirements:
- You’re enrolled in an HDHP
- You don’t have other health coverage
- You’re not enrolled in Medicare
- You’re not claimed as a dependent on anyone else’s tax return
If you utilize Medicare, you can’t open an HSA or contribute to one. However, you can use the account for medical expenses if you already have an HSA and have recently enrolled in Medicare.
Can I Qualify If I’m Self-employed?
Self-employed people qualify for an HSA, like anyone with an HDHP. This includes small business owners, independent contractors, and gig economy workers like Uber drivers.
The same rules apply to those with employer-based insurance, such as the requirement not to have other insurance and are not claimed as a dependent on someone else’s taxes.
You can withdraw funds from the HSA tax-free to pay for qualified medical expenses. These include vision care, dental services, prescription medication, copays, hospital care, and addiction treatment. Distributions from the HSA for other than qualified expenses are subject to income tax and a 20% tax penalty. The 20% penalty ends once a person turns 65, but the income tax remains on non-qualified withdrawals.
Insurance premiums are not an eligible expense, with a few exceptions. If you’re receiving unemployment compensation or paying for health premiums under COBRA, you can use HSA funds. Medicare and other health care coverage are eligible if you are 65 or older. An HSA will reimburse you for long-term care insurance premiums up to limits established each year.
Advantages and Disadvantages of an HSA
As with any choice related to health insurance, there are advantages and disadvantages of an HSA. Here are several of the most prominent:
- Having an HSA provides valuable tax benefits. Your employer’s and your contributions both reduce your taxable income. Direct contributions to an individual HSA are entirely tax deductible.
- You can invest the funds in your HSA account; any earnings are tax-free. No tax is paid on withdrawals from the HSA if you use the funds for qualified medical expenses.
- The funds roll over from year to year. There is no “use it or lose it” policy as there is with a flexible spending account. If you don’t use the funds for medical expenses, the account grows tax-free for years to become an asset to use in retirement.
Having an HSA usually means using a high-deductible health plan. A high-deductible health plan entails that, for the insurance to pay for medical care outside of your primary care provider or other essential services, you will pay a higher-than-average amount out of pocket before the insurance beings to pay.
For context, an HDHP is considered any healthcare plan with a deductible between $1400 for an individual and $2800 for a family. Your annual HSA contribution won’t cover the full amount, so if you don’t have enough cash to make up the difference, you’ll wind up with expensive medical bills.
HSA vs. Flexible Spending Account (FSA)
Both flexible spending accounts (FSA) and HSAs pay for medical expenses. But there are important differences in how they function.
Employers sponsor FSAs, and only employed individuals can use them. Your FSA contribution is also in pretax dollars, reducing your taxable income. The annual FSA contribution is capped at $2,850 in 2022.
FSA funds pay for qualified medical expenses incurred during the coverage period. You qualify for an FSA if your employer offers it, regardless of the type of health insurance you choose.
You put funds in your FSA by payroll deduction, but IRS rules let you use your full annual contribution even if you haven’t deposited it yet. Imagine if you had an injury in February and had only contributed $475.00 to your account. If you had chosen an annual contribution of $2,850, you could still use the entire amount to cover your qualified expenses.
At the end of the year, you forfeit any unused funds in the FSA; therefore, unlike HSAs, they do not roll over. However, some plans offer a grace period of 2.5 months after the year’s end. When you change jobs, you usually lose your FSA.
An FSA works for a budget-conscious person who does not want to pay a high deductible. You can access your total annual contribution from the beginning of the year to help you save money.
Who Should Consider An HSA?
An HSA works for healthy people with few medications or medical visits. It’s a good choice for those who prefer the higher contribution limit and the ability to roll over the benefits for future use. Some advisors recommend using an HSA as a tax advantage savings tool to build assets to use in retirement.