Health Savings Account (HSA) Explained

High-deductible health plans have low monthly premiums; however cost-sharing by the insurance carrier – when your insurance company starts helping you pay your medical bills – doesn’t kick in for most services until you’ve meet a pretty high deductible, often $3,000 or more. The idea behind an HSA – pairing a health-expenses-only savings account with a qualifying high-deductible health plan – is that you’ll be more careful about how you spend your healthcare dollars because you’re paying more of your medical bills out of your own pocket. At least that’s the theory.

If you’re eligible, you can set up an HSA on your own (through a bank or other financial institution that offers it) or through your employer. As far as deciding whether an HSA is a good choice for you, you’ll need to think about your healthcare needs, and your budget.

An HSA can save you a bundle if you’re generally healthy and you don’t think you’ll need much medical care in the near future. Here’s how:

1. If you typically don’t use a lot of healthcare, you’ll save money on the (lower) monthly premiums. Not only that, you don’t pay taxes on money you put into your HSA, even when you withdraw it to pay for a qualified medical expense. (On the flip side, if you’ve got any health issues that require frequent medical attention or regular medications, going with an HSA and a high-deductible plan might not be your best option.)
2. If you have an HSA through your employer, you have the option of making pre-tax contributions. So any money you tell your employer to put into your HSA is deposited before taxes, so you’ll reduce your taxable income. For instance, say you make $35,000 a year, and you tell your employer to put $2,000 into your HSA, your taxable income will only be $33,000.
3. Money that accumulates in your HSA can grow as earnings or interest accumulate tax-free. And any unused funds are rolled over each year (meaning it stays in the account, with you). So if you don’t use it, you don’t lose it. (If you pass away before using up the money in the account, you can leave the remaining money to your spouse to continue using as an HSA.)

For 2015, individuals can contribute up to $3,350 per year into an HSA. Or up to $6,650 if you have family coverage. If you’re between the ages of 55 and 65 you can sock away an additional $1,000 as a “catch-up” contribution. Just remember that HSA funds are only tax-free when used for what the IRS calls qualified medical expenses such as doctor’s visits, hospital stays, and prescription medications. Be aware that if you use HSA funds for non-qualified expenses before you’re 65 years old, you’ll not only have to pay income tax on those funds, you may also have to pay an additional 20 percent penalty fee.

You can only make contributions to your HSA while you’re enrolled in a qualifying high-deductible plan. If you switch to a different type of plan, you’ll no longer be able to put money into the account; however, any funds you’ve accumulated can still be used – tax-free – to pay for future qualifying medical expenses. Again, the money stays with you.

The bottom line: A health savings account may be a good choice for you if you’re generally in good health and you’d like to put away some tax-free funds to use for future healthcare expenses. If you’re close to retirement, an HSA might make sense because any money you save (while you’re still working) can be used to pay for medical care after you retire.

What else you need to know

HSAs do have their downside. Healthcare needs can arise out of nowhere. Perhaps you notice an unusual symptom, or just don’t feel well, but you put off going to the doctor to try to save money. You could risk a minor health problem becoming a major headache. (Which defeats the point of having health insurance.) Plus, if you dip into your HSA for anything other than qualified medical expenses, you’ll have to pay income taxes, plus that additional 20 percent penalty tax (unless you’re 65 and older, or you’re disabled) on whatever you withdraw.

If you’re opening your own HSA, rather than through an employer, think about whether you’re the type of person who will put money aside. Can you give up your daily grande non-fat decaf two-pumps-vanilla no-foam latte and put that money away?!

Something else to think about is your age. Once you’ve applied for social security, you’ll automatically be enrolled in Medicare Part A, and that means you can no longer make contributions to your HSA. In fact, the IRS says you can’t make any more contributions up to six months before going onto Medicare.