Introduction

Healthcare costs can be a significant burden for many individuals and families. One way to manage these expenses is through a Health Savings Account (HSA). These accounts were introduced effective January 1, 2004 courtesy of the Medicare Prescription Drug, Improvement, and Modernization Act signed by President George W. Bush.

HSAs are savings accounts where you save pre-tax dollars that can be used for certain medical expenses that your health insurance is not paying for. Like any financial product, they have their pros and cons, and it’s important to understand both before deciding if this is the right option for you and your family.

While HSAs are available through a variety of institutions, if you get your plan through your employer they will usually contract with a specific company that you’re required to use.

What is an HSA

Basically, a Health Savings Account is a tax-advantaged way to set aside money to pay for medical expenses.

If you get it through your employer, they’ll take the money out of your check before they calculate any taxes. If you have a standalone plan, you’ll generally take your contributions into account if you make estimated tax payments and when you file at the end of the year.

The main requirement to open an HSA is that you’re enrolled in a High Deductible Health Plan (HDHP). The idea is that it is a way to cover the higher out-of-pocket expenses associated with an HDHP using money that is not subject to taxes.

Annual Contribution Limits and Deductible Minimums

There’s two key numbers to keep in mind with HSAs and HDHPs:

• Annual contribution limit for the HSA.
• Minimum deductible for your health insurance plan to qualify as an HDHP

HSA Contribution Limit for 2023

The maximum you’re allowed to contribute to your HSA account is indexed to inflation and can change each year. Your limit is controlled in part by the level of medical coverage you have (self-only vs. family) and your age.

For 2023, the contribution limits are

• Self-only: $3,850
• Family (any level higher than self-only): $7,750

In addition, if you will be age 55 or older in 2023, you can put in another $1,000 as a catch-up contribution. This is similar to how a lot of retirement plans work.

HDHP Deductible Minimums for 2023

As with the contribution limits, the IRS sets minimum deductible amounts each year for a medical plan to be considered an HDHP. Remember: You can’t save in an HSA unless you’re enrolled in a qualified HDHP.

These deductible amounts are also based on your coverage level. But there’s no age-based adjustment. For 2023, they are

• Self-only: $1,500
• Family: $3,000

However you get your medical insurance – through your employer, on a health insurance exchange, through a professional association, etc. – the enrollment materials should make it clear if a plan is a qualifying HDHP that will let you set up a healthcare savings account.

Basics of How an HSA Works

Any contributions you put into one of these plans goes into an individual account with the financial institution or administrator used by your employer or chosen by you, whichever is applicable.

With most institutions, you will have investments options so you can potentially get earnings on the funds. But you’ll often need to reach a minimum amount of savings before you have access to those investments.

Using or getting access to your health savings is usually pretty straightforward. Every provider I’ve every interacted with has a way for you to log into your account online and request a withdrawal straight to your linked checking or savings account. You might even have access to a debit card that can be used at the doctor’s office or pharmacy.

What are the Pros of an HSA?

While there’s a number of advantages to using an HSA, here are several key items to take into consideration.

Tax Savings

Just so long as you’re enrolled in the right kind of medical plan, your contributions are all tax-free. And if you earn anything on the funds in your account, those earnings accumulate tax-free.

Provided your withdrawals are for allowable medical expenses, you don’t pay any taxes on the funds or earnings.

Portability

Once the funds are in your account, they’re yours and can be carried with you if you change jobs and when you retire.

And, unlike an FSA account, your contributions roll over from year to year if you don’t use them. There’s no “use it or lose it” rule with an HSA. This is one of my favorite features of the HSA since I can’t always predict how much I’m going to have in medical expenses each year. Anything unused just stays in my account for future use.

Flexibility

If you decide to simply pay for your medical expenses out-of-pocket and not touch the money in your HSA, you can do that. I know several people who are in the fortunate position of being able to treat their HSA as essentially another retirement account to further maximize their tax-sheltered savings. They never touch the funds in the account, just letting them accumulate.

They’re great if you’re using alternative therapies that the IRS recognizes as allowable expenses but aren’t covered by your insurance plan. Common examples I’ve seen over the years are things like acupuncture and chiropractic.

One interesting feature of these plans is how you can use them once you turn 65 and are on Medicare. While you can’t contribute to an HSA while on Medicare, you can use any funds you already have in the account to cover the premiums for Medicare Part B, Medicare Part D, and Medicare Advantage plans. Plus, of course, continue to use the funds for actual out-of-pocket medical expenses.

What are the Cons of an HSA?

High Deductibles

Probably the biggest drawback with these accounts is that you have to be enrolled in a high deductible plan.

While the minimum deductible is $1,500 for self-only coverage – well below the maximum HSA contribution – you might only have access to a plan with a much high deductible. At my employer, for example, the lowest deductible option I have is $3,800, and I’ve seen plans with even higher amounts.

If you don’t have enough cash cushion to cover your medical expenses until you’re able to get funds out of your health savings account, this might not be a good option for you. And if you have a serious medical condition, it’s easy – with the co-insurance and co-pays you might be subject to even after meeting your deductible – to have expenses that are higher than what you can put away in your account.

Record Keeping

Because the IRS defines what are allowable medical expenses, you have to take responsibility for understanding those rules and also for keeping the right paperwork in case you’re audited. That paperwork includes things like explanations of benefits and itemized receipts from your medical providers.

You’ll receive additional tax forms each year from your employer and the financial institution where you have your account. You’ll need to reference these when filing your taxes – there’s even a special worksheet you’ll need to complete to make sure you didn’t contribute too much to your account.

Conclusion

While Health Savings Accounts can be a great option for some people, they are not suitable for everyone. While you gain tax savings and flexibility, it might require some planning to make sure you have an adequate cash cushion to manage the ebb-and-flow of expenses vs reimbursement.

Additionally, if you prefer a comprehensive health insurance plan – which will usually have higher premiums but lower out-of-pocket costs – an HDHP/HSA may not be the best choice for you.