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The 101 on Health Savings Accounts

Jessica Easto
Jessica Easto is a writer and editor based in Chicago. Her primary areas of expertise include personal finance, risk management, and small business. Her book Craft Coffee: A Manual teaches you how to make cafe-quality coffee at home on a budget.
Updated on March 18, 2021
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An HSA can help you avoid going into debt over unexpected medical expenses. Learn how they work and how they can boost both your savings and take-home pay.

National Health Savings Account (HSA) Awareness Day was  October 15, but that doesn’t mean we should stop talking about ways to save and hang on to our hard-earned money.

As a follow up to HSA Awareness Day, we thought we’d explore this highly beneficial savings tool.

Although more and more Americans are signing up for health savings accounts (22 million in 2017, according to one survey), many folks who are eligible to open an account don’t have one. Today we’ll examine HSAs by exploring what they are and who qualifies for one, along with the pros and cons of opening one.

Health savings accounts: an overview

Health Savings Accounts, or HSAs, were first established on a federal level in 2003, via the Medicare Prescription Drug, Improvement, and Modernization Act, to help people with potentially expensive health insurance plans pay for medical expenses.

In simpler terms: They are tax-advantaged personal savings accounts that allow you to save money specifically for health expenses. What does “tax-advantaged” mean? It means the money you save is taken out from your paycheck before you are charged income taxes on the rest. In other words, you don’t have to pay taxes on the money you save, as long as you use it for a qualifying expense (more on that in a moment).

Who is eligible for an HSA?

Unfortunately, not everyone qualifies to open an HSA. In order to be eligible, you must first be enrolled in a high-deductible health insurance plan, or an HDHP. As of 2019, the IRS defines an HDHP is any health insurance plan in which the deductible (the amount you have to pay toward medical costs before certain insurance benefits kick in) is at least $1,350 for an individual or $2,700 for a family.

With an HDHP, you can’t have yearly out-of-pocket expenses (all the deductibles, coinsurance, copays, etc. that you are responsible for) greater than $6,750 for an individual or $13,500 for a family. If you have one of these plans, you will want to make sure you understand all of the potential out-of-pocket costs that may surprise you.

It’s important to keep in mind that the IRS changes how it defines HDHPs. For example, in 2020, the HDHP’s deductibles will increase to at least $1,400 for an individual and $2,800 for a family. You should check the IRS’s HSA page for the latest information every year.

If you do have an HDHP, you still have to meet other criteria in order to be eligible for an HSA: You can’t have other health insurance (unless it’s eligible coverage, such as dental and vision coverage), you can’t be enrolled in Medicare, and you can’t be claimed as a dependent on someone’s tax return.

Why is an HSA beneficial?

When used correctly, HSAs can be extremely beneficial. Think about those HDHP deductible and other out-of-pocket costs. When you or your family needs medical attention, you are on the hook for at least as much as your deductible (as much as $2,700) and a max of $13,500 — an amount that is easy to rack up in the United States, where average medical costs are inflated and far outstrip those in other developed nations. Do you have $13,500 (or even $2,700) laying around in a given year? Probably not, which is why the HSA is around. It helps you save for the unexpected so you don’t have to tap into other means to cover your emergencies.

HDHPs are attractive to those on a budget because they tend to have lower premiums t he upfront money you pay every month for your coverage. Theoretically, the money you save on premiums can be funneled tax-free into an HSA, where it will accrue tax-free interest until you need to spend it  on qualified medical expenses. You will not be taxed to use the funds either.

If you save a little bit each month until you have enough to pay for your deductible, for example, then you’d never have to worry about being able to afford your deductible when medical expenses crop up (and they always do).

Additionally, the money you contribute to an HSA has the potential to reduce your taxable income, which means you may not have to pay as much in income taxes. That gives you more real spending money.

Medical debt is a huge problem in the United States. In 2018 Americans collectively borrowed $88 million for medical expenses they couldn’t afford.

How much money can you save in an HSA?

Every year, the IRS determines the max amount of money you can contribute to an HSA. In tax year 2019, you can contribute up to $3,500 a year if you have an individual plan, or up to $7,000 in the year if your family is also covered on your plan. In 2020, you’ll be able to contribute up to $7,100 if you have a family plan.

The money you save in your HSA account rolls over from one year to the next, so your savings can keep growing and growing as long as you contribute. And one of the best things about HSAs? The money is always yours to spend, even if you have to drop your HSA-eligible plan, such as when you change jobs or switch to an insurance plan that is no longer eligible.

How can you spend your savings?

Okay, so what can you spend your savings on? Qualified medical expenses, which the IRS defines “as any expense used to relieve or prevent a physical or mental defect or illness, including dental and vision issues.”

While these expenses do not include your monthly premiums, they do include a lot of other things, such as doctor visits (copays, deductibles and coinsurance), dental procedures, eye exams, chiropractic services, prescriptions, and more. The IRS regularly updates what it considers to be “eligible services,” so be sure you always double check the latest federal information.

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