What Is a Health Savings Account?

Health Savings Accounts or HSAs are tax-advantaged accounts used to save funds for qualified medical expenses by persons who are covered by high-deductible health plans (HDHPs). Individuals or their employers contribute money to the account, which is limited to a certain amount per year. The funds are invested over time, and one may use them to cover qualified medical expenses such as dental, medical, eye care, and prescription pharmaceuticals.

People can now use HSA money to purchase over-the-counter pharmaceuticals without a prescription, and various other health-related items, according to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which members introduced into law in response to the Covid-19 outbreak. Plan members confused about which expenses are eligible can contact their pharmacist or HSA administrator for clarification.

It is essential to note that if money is taken out of an HSA to pay for something other than a qualified medical cost, it is subject to income tax as well as a 20 percent tax penalty.

How Health Savings Accounts Work

An HSA can be opened by individuals with HDHPs, as previously stated. People with HDHPs may be eligible for HSAs, and the two are frequently coupled. To be eligible for HSAs, a taxpayer needs to meet the Internal Revenue Service’s eligibility requirements (IRS). A person who meets the following criteria is considered a favorable candidate:

  • Contains a qualified HDHP
  • Does not have a Medicare enrollment
  • Does not have any form of health coverage
  • Has no claim on another individual’s tax return as a dependent

In 2021, a person can contribute $3,600 to an HSA, and a family can contribute $7,200. The yearly contribution restrictions apply to the full sum contributed by the employee and employer in a given year. People who are 55 years or older before the end of the tax year may make $1,000 catch-up contributions to the HSAs.

A health savings account (HSA) can be obtained at a variety of financial institutions. Employee-sponsored programs may be supported by both the employee and the company; however, one must pay contributions in cash. Any other person, such as a family member, may add to an eligible individual’s HSA. People who are self-employed or jobless can contribute to HSAs if they satisfy the eligibility conditions.

As of the initial month after enrolling in Medicare, people cannot contribute to HSAs. However, these people are eligible for tax-free payouts regarding qualified medical expenses.

What Are the Advantages and Disadvantages of Health Savings Accounts?

There are various advantages and disadvantages associated with health savings accounts. Essentially, the impact of these accounts is completely dependent on the individual’s financial and personal situation.

Benefits of HSAs

A person’s payroll deduction contributions and employer contributions to HSAs are not included in an employee’s taxable income. Additionally, direct additions to the HSA are tax-deductible to the full extent of the worker’s income. The account’s earnings are tax-free. Excess contributions made to HSAs, on the other hand, are taxed at 6% and are non-deductible.

HSA distributions are tax-free if the money is spent for eligible medical costs as defined by the IRS.

Distributions utilized for HDHP-covered medical costs are included in assessing whether the HDHP’s deductible has been reached.

One can use their funds in an HSA to invest in other securities such as stocks, which creates the potential to earn higher returns over specific time periods.

Disadvantages of HSAs

The most significant problem is that one must be a good HDHP prospect. You either have a high-deductible plan with low insurance rates, or you need to be wealthy enough to afford large deductibles and take advantage of tax benefits.

People who finance their personal HSAs, whether via payroll deductions or in a direct method, ought to be able to save enough money to cover a significant percentage of their HDHP deductibles. The high deductible level may be challenging for those who do not have sufficient cash to put down in an HSA.

An HSA may also have contribution disclosure requirements, withdrawal regulations, distribution reporting standards, and a record-keeping responsibility that can be challenging to maintain.

Contribution Rules Regarding Health Savings Accounts

An HSA contribution is not required to be withdrawn or used during the tax year. You can retain these funds, and any additions that you do not use may be carried over to the following year. Furthermore, HSAs are transferable, which means that workers can maintain their HSAs even if they change employers. 

Upon the passing of an account holder, the HSA program can be tax-free transferred to a surviving family member or spouse. The fund is no longer viewed as an HSA if the designated beneficiary is not the account holder’s spouse; the successor is taxed on the profile’s fair market value and modified for any eligible medical costs paid from the account within the year of the deceased’s death.

The Difference Between HSAs and Flexible Savings Accounts (FSAs)

People frequently compare the health savings account to a flexible savings account. While both portfolios can be utilized for medical bills, they have some significant differences:

FSAs are employer-sponsored programs that are only available to employees. Unused money in FSAs during given tax years cannot be carried over and is discarded when the year ends.
Unlike HSA contributions, the amount you choose to contribute to the FSA is fixed.
Regarding the 2021 tax year, the maximum contribution to a flexible saving account is $2,750.

Conclusion

Overall, an HSA is one of the most effective tax-advantaged investment and savings vehicles available underneath the United States tax code. Since contributions are tax-free, the funds can be deposited and increase tax-free, and withdrawals are tax-free if they are used for qualified medical costs; they are generally described as triple tax-advantaged accounts.

Medical costs tend to rise as an individual gets older, especially as they approach retirement age and beyond. If you are eligible, starting an HSA at a young age and enabling it to grow over a period of time can help one secure their financial future.