HSAs have been touted as this magical new way of reducing medical costs and taxes that can even help you save for retirement. In fact, an HSA is pretty great in certain ways, but only if qualify for one and you don’t use up all the money paying astronomical medical expenses. 

So what is an HSA?

An HSA in the U.S. is a Health Savings Account. According to healthcare.gov, an HSA is a “type of savings account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses.” Although you cannot use it to pay insurance premiums, you may use it for deductibles, copays, prescriptions, dental procedures, eyeglasses, and many other expenses as long as you are not receiving reimbursement from your health insurance company. A full list can be found in the IRS publication on HSAs.

What are the advantages of an HSA?

HSAs are great because of the tax advantages you receive.

1. You don’t pay any taxes on income put in an HSA. Or, if you open an account that is not through your employer, you can deduct the contribution.

2. The amount put in your account reduces your taxable income, lowering the amount of income tax you will owe.

3. The money in an HSA can be invested and any growth in the amount will not be taxed as long as it is used for eligible medical expenses. Contributions do not have to be used and can sit in your HSA forever if you don’t need the money.

When you are over 65, you may use the money for any expense, though you will need to pay income taxes at the time you withdraw an amount for non-medical expenses. Prior to age 65, there is a 20% penalty if you use the money for ineligible expenses.

Who is eligible? 

One of the downsides of HSAs is that you are only eligible to have one if you are enrolled in a qualified high deductible health insurance plan. When you sign up for health insurance, your employer should be able to tell you if your plan qualifies. Many employers who offer a qualified program will also offer an HSA. However, if your employer does not, you may sign up for one on your own. 

How much can I contribute?

Healthcare.gov will list the current contribution limits. For 2020, those limits are $3550 for an individual and $7100 for family coverage. 

Employers may also contribute to your HSA.

How is this different from an FSA?

FSAs, or flexible spending accounts, are similar in the expenses they cover. However, an FSA must be used by the end of the year unless the employer allows a rollover for one year, which is usually not more than $500. FSAs have wider eligibility and also allow you to pay medical expenses using pre-tax money. Generally, you are not allowed to have both. 

If I’m eligible, should I use an HSA to save for retirement?

You should never sign up for an HSA and high deductible health plan just for the retirement savings benefit. The decision to go with this type of health plan should be made based on your healthcare needs and costs, not on potential tax benefits (especially since the tax benefits aren’t worth as much if you’re in a low tax bracket).

High deductible plans only make sense for people who are unlikely to have a lot of medical expenses. Generally, this means young, healthy, single people. 

If you do choose a high deductible health plan and get an HSA, it does make sense to put as much as you can in it and let it grow for the future. Paying your medical costs out of your regular checking or savings account and leaving your money in the HSA will give you the most benefits. Ideally, you’ll end up with a nice nest egg to pay for your increased medical costs in old age.

If a high deductible plan is not right for you, consider maximizing contributions to your 401k, IRA, Roth IRA, or other retirement plan. A financial advisor can help you determine the right retirement savings vehicle for you and how much to put in it.

Conclusion

HSAs offer many advantages to those for whom a high deductible plan makes sense from a healthcare costs perspective. Unfortunately, many people will not benefit from a high deductible plan. For them, it makes more sense to get more comprehensive medical insurance and save for retirement using a more traditional retirement savings account.