What is an HSA, and how does it work?

What is a health savings account?

A health savings account, or HSA, is like a financial tool designed to help folks with high-deductible health insurance plans handle their medical costs. It’s pretty nifty because it lets you pay for healthcare using money that hasn’t been taxed yet. But here’s the cool part – you can also invest the money in your HSA to save for when you retire.

Now, let’s break down what makes HSAs special:

• You can only contribute to an HSA if you have a specific type of high-deductible health insurance plan.

• Either your employer can set up an HSA for you and even chip in some money, or you can open one yourself and make contributions.

• Unlike some other savings accounts, you can let your HSA money grow without being forced to take it out at a certain age. For example, 401(k)s and traditional IRAs usually require you to start taking money out after you turn 72.

• If you use HSA funds to pay for qualified medical expenses, you won’t have to pay taxes, no matter your age. But with things like 401(k)s and IRAs, you usually can’t touch the money before you’re 59 1/2 without paying extra taxes, unless you meet specific conditions.

• Now, if you decide to use your HSA money for anything other than qualified healthcare expenses before you’re 65, there’s a steeper penalty – 20% plus regular income taxes. That’s double the penalty you’d face with early withdrawals from 401(k)s or IRAs. However, once you hit 65, you can take out HSA funds for any reason, and you’ll only pay regular income tax if it’s not for healthcare expenses.

What’s the deal with HSA’s? How do they operate?

Think of health savings accounts as a handy way to save money for healthcare and retirement. But here’s the catch: there are some rules you need to keep in mind, like who can use them and how much you can put in each year.

And just so you know, these rules for health savings accounts are quite different from those for flexible spending accounts (FSAs), even though both let you use tax-free money to cover medical expenses

Investing with HSA

One of the best things about HSAs is that they’re not just a regular savings account for your healthcare needs. They actually let you invest the money you put in there, so it’s not just sitting around as cash. This means you can:

• Invest money before it’s taxed in the stock market.
• Watch your money grow through investments without having to pay taxes on the profits.
• Take out your money without any taxes if it’s for medical stuff, even the gains you’ve made from investing.

No other type of investment account lets you do this – put money in before it gets taxed, make money from your investments, and never owe taxes on the gains. Because the IRS doesn’t dip into your earnings, an HSA can be a super-effective way to build up wealth since everything your investments make is entirely yours to keep.

Now, let’s talk about what happens if you decide to use your HSA money for things other than medical expenses. If you do that, the government will take a portion of it in taxes, just like your regular income. Plus, if you’re under 65, there’s an extra 20% penalty. But here’s the bright side: you still get to invest your money before taxes and delay paying taxes on any gains, similar to how a 401(k) works.

Depending on where you open your HSA, you’ll have different options for investing. Typically, you’ll find index funds, which are kind of like bundles of stocks that track the whole market or specific types of companies like big, medium-sized, or small ones. You might also have access to bonds, real estate, or funds related to emerging markets.

Investing in these funds is usually pretty straightforward, even if you’re new to investing. Plus, it’s less risky than buying individual stocks. So, if you want to dip your toes into the stock market and save on taxes at the same time, using your HSA as an investment tool is a smart move.

But here’s a tip: if you plan to use your HSA money in the next two to five years, it’s a good idea to keep it in cash or something similar. That way, you won’t be affected by the ups and downs of the stock market.

On the other hand, if you’re looking to let your money grow for future healthcare expenses or to beef up your retirement savings, investing your HSA funds is a wise choice.

Who’s eligible to put money into an HSA?

You can stash money in an HSA as long as you’ve got one of those high-deductible health plans, and there’s no other insurance with a lower deductible (like Medicare). Now, what makes a high-deductible plan? Well, it changes every year, but there are two things it must do:

• Your deductible has to be at or above a certain dollar amount.
• Your plan should cap the most you’ll pay out of your pocket under a specific limit.

Take a look at the chart below for the minimum deductible and maximum out-of-pocket costs that a high-deductible health plan needs to meet in 2022 and 2023. Remember, your eligibility depends on your plan meeting these rules each year. So, if it checks all the boxes in 2022 but not in 2023, you can save money in your HSA in 2022 but not in the next year.

Source: IRS

Yearly contribution limits

There are rules about how much money you can put into an HSA each year, and the limits depend on whether it’s just for you or for your whole family. These limits change every year, and if you’re 55 or older, you can put in an extra $1,000 as a “catch-up” contribution.

For 2023, here are the annual contribution limits:

• If it’s just for you, you can contribute up to $3,850 (It was $3,650 in 2022). If you’re 55 or older and can do catch-up contributions, it’s $4,850 (It was $4,650 in 2022).
• If you’re covering your whole family, the limit is $7,750 (It was $7,300 in 2022). With catch-up contributions, it’s $8,750 (It was $8,300 in 2022).

Keep in mind, if your employer chips in money for your HSA, that counts toward these yearly limits. So, if your employer adds $1,000, and you have self-only coverage, you can only add an extra $2,650 in 2022.

Also, you’ve got some time to make these contributions. You can put money into your HSA until the tax deadline for the year. So, for example, you can fund your HSA for 2022 all the way up until April 18, 2023.

HSAs vs. FSAs

Health savings accounts and flexible spending accounts are both ways to pay for medical costs using money that hasn’t been taxed yet, but they have some important differences:

• Investing: With an HSA, you can invest the money you put in, which can grow over time. But with an FSA, investing your money isn’t an option.
• Eligibility: FSAs are more widely available. Anyone whose employer offers them can have an FSA, and you can use it for healthcare expenses as well as dependent care. HSAs, on the other hand, are typically for people with high-deductible health plans.
• Timeframe: When you put money in an FSA, you usually have to use it within the same year. But with an HSA, your funds can keep growing, and you can take them out whenever you need, even in the future.

So, while both accounts can help you save on taxes for medical expenses, HSAs have some extra perks like investment opportunities and more flexibility if you’re eligible.

How to start and put money into an HAS

If you’ve got one of those high-deductible health plans that qualify, your employer might offer an HSA, which can be pretty enticing, especially if they’re chipping in some money too.

On the other hand, you can also find HSAs at different financial institutions. For instance:

Lively has HSAs that come with a savings account that’s insured by the FDIC, and you can even invest your HSA money using TD Ameritrade’s platform, giving you the freedom to choose from a wide range of stocks, bonds, ETFs, or mutual funds.

HSA Bank also offers HSAs, and you can invest through TD Ameritrade or use a program that guides you in investing your money into low-fee mutual funds.

Now, here’s the thing to keep in mind: even though you can have multiple HSAs, there are limits on how much you can put into them all combined. So, you need to keep track of how much you’re contributing to all your accounts in a year. And you’ll have to fill out a separate Form 8889 for each HSA, which can be a bit of a hassle. That’s why many folks stick to just one HSA, either the one from their employer or one they set up themselves.

The decision really comes down to what works best for your goals. If your employer is pitching in for a particular HSA, it’s often an easy choice. But if not, it’s a good idea to compare your employer’s plan (if they have one) with a few other options. For example, if you want to invest in individual stocks using your HSA, you’ll need to find a place that lets you do that.

So, here’s the key takeaway about HSAs…

HSAs are like a special savings tool that lets you save money for healthcare without paying taxes on it upfront. But here’s the cool part – you can also invest this money, watch it grow, or just leave it as cash. So, HSAs aren’t just for covering medical bills; they can be a way to grow your money over time.

If you use your HSA as a long-term savings and investment account, it could turn into a helpful way to pay for healthcare when you retire. Plus, along the way, it can lower the taxes you have to pay. So, it’s kind of like a double win – saving for the future and cutting your tax bill.