A health savings account (HSA) allows you to save money for future medical expenses while enjoying special tax incentives. Your contributions reduce your taxable income, and your money grows tax-free. Withdrawals are also tax-free, as long as you use the money for qualified medical expenses.
HSAs have become more popular in recent years. By the end of January 2021, there were $82.2 billion in 30 million accounts, a 25% year-over-year jump in assets and a 6% increase in the total number of accounts.
Here’s how to open an HSA and how you can make the most of your savings.
How to Qualify for an HSA?
To open an HSA, you need to associate it with a health plan known as a “High Deductible Health Plan (HDHP).
What is an HDHP?
In this type of plan, the premium is generally lower, but you pay more out-of-pocket medical costs before the insurer starts paying its share when you need it.
For 2022, the Internal Revenue Service (IRS) defined an HDHP as any plan where the maximum out-of-pocket medical expenses paid by the individual do not exceed $7,050 for an individual or $14,100 for a family. (This limit does not apply to out-of-network services.)
Therefore, if your plan meets these requirements, you can open an HSA. You can open one at most banks and financial institutions across the country.
Tax Benefits of an HSA
The money that goes into an HSA comes out of your gross income. This means that this amount reduces your taxable income.
For example, let’s say you are single and earn $40,000 a year. You contributed $3,000 to your HSA this year. This means the IRS will tax you as if your annual gross income were $37,000, not $40,000.
Additionally, your money grows tax-free, meaning you won’t be taxed on interest earned. Even tax-protected retirement savings accounts, like 401(k)s, do not receive this treatment.
And your withdrawals are also tax-free if you use them for qualified medical expenses as defined by the IRS.
However, your earnings may be taxed at the state level. But for now, more than 30 states, including New York and Pennsylvania, do not tax HSAs.
Contribution Limits
The IRS sets contribution limits each year. But these are typically high. For 2022, the maximum HSA contribution is $3,650 for an individual plan or $7,300 for a family plan.
But if you are at least 55 years old, you can make an additional $1,000 contribution to your account.
What Does an HSA Cover?
Qualified medical expenses include treatments to alleviate or prevent physical or mental illnesses. Thus, you can use your HSA funds to cover everything from acupuncture to X-rays.
You can also use HSA funds to reduce your deductible. This is the amount you must pay out-of-pocket for medical expenses before your insurer starts covering costs. But you can also use HSA money to cover copayments and coinsurance.
Additionally, you can use your HSA to pay for eligible dental and vision expenses, even if your health plan does not cover these services. Furthermore, these benefits extend to your spouse and any dependents under 26 years old, even if they are enrolled in different health plans.
Do not expect to use your HSA money for expensive gym memberships or to cover services like teeth whitening, cosmetic surgery, or over-the-counter medications.
For a complete list of qualified medical expenses for HSAs, visit Section 213(d) of the Internal Revenue Service Tax Code.
What If I Need the Money in the HSA for Another Purpose?
If you use the HSA for a purpose other than eligible medical expenses, you may be subject to significant IRS penalties. In addition to paying tax on the amount withdrawn, you will have to pay a 20% penalty.
However, if you do not need to use the money for medical expenses, your HSA funds can be used for non-medical purposes without penalty once you reach 65 years old. Thus, HSAs can also serve as an investment account for retirement.
Source: SmartAsset