Health savings account: Learn about this option and find out if it’s worth opening one

If you’re looking for a way to manage healthcare costs while saving on taxes, a Health Savings Account (HSA) might be the perfect solution.

This type of account is designed to help individuals save for medical expenses and offers several tax advantages, making it an attractive option for many. But is it really worth it?

So, if you want to learn more about how a health savings account works, keep reading to understand if it’s really worth opening one!

What is a health savings account?

An HSA is a type of savings account specifically meant for medical expenses. It allows you to set aside money before taxes are deducted, meaning contributions reduce your taxable income.

Not everyone is eligible for an HSA — to qualify, you need to be enrolled in a High Deductible Health Plan (HDHP).

The idea behind HSAs is simple: you contribute money tax-free, let it grow through investments, and use it tax-free for healthcare expenses.

Any unused funds roll over to the next year, allowing the balance to grow over time, similar to a retirement savings account but with the added tax benefit for medical costs.

Understanding how a health savings account works

HSAs are paired with high deductible health plans (HDHPs), which have lower premiums but higher out-of-pocket costs.

Once you’re enrolled in an HDHP, you can contribute pre-tax income to your HSA.

The money in your HSA can then be used to pay for eligible medical expenses such as doctor visits, prescriptions, and even some medications.

Your contributions grow tax-free, and you can even invest the funds in stocks, bonds, or mutual funds, depending on your HSA provider.

If you don’t use the funds by the end of the year, they roll over to the next, unlike a flexible spending account (FSA), which has a use-it-or-lose-it rule.

Key conditions of this account

While HSAs offer many advantages, it’s essential to understand the conditions that come with them. Here are some of the most important:

• Eligibility: To open an HSA, you must be enrolled in a qualified HDHP. For 2024, the minimum deductible for an HDHP is $1,600 for individual coverage and $3,200 for family coverage.
• Contribution limits: The IRS sets annual contribution limits for HSAs. For 2024, you can contribute up to $4,150 for individual coverage or $8,300 for family coverage. People aged 55 or older can make an additional catch-up contribution of $1,000 per year.
• Qualified expenses: HSA funds can only be used for medical expenses approved by the IRS. If you use your HSA for non-medical expenses before age 65, you will face a 20% penalty plus taxes on the withdrawn income. After age 65, you can withdraw money for any reason, but non-medical withdrawals will be taxed as ordinary income.

Advantages of a health savings account

HSAs offer a range of benefits that can make them a smart choice for those looking to save on healthcare expenses.

Portability

HSAs are completely portable, meaning they belong to you, not your employer. If you change jobs or switch health insurance providers, your HSA stays with you.

This differs from flexible spending accounts (FSAs), which often have use-it-or-lose-it provisions tied to your employer.

Tax-free withdrawals

One of the biggest advantages of an HSA is that withdrawals for qualified medical expenses are entirely tax-free.

This includes expenses like prescriptions, surgeries, and even dental and vision care.
If you use the funds for approved medical purposes, you won’t pay any taxes or penalties.

No initial deposit

Many HSA providers don’t require an initial deposit to open an account, making it easy to get started.

You can begin funding your HSA through payroll deductions or direct contributions without worrying about needing a large starting amount.

Pre-tax contributions

Contributions to an HSA reduce your taxable income, which can result in significant tax savings.

For example, if you earn $50,000 a year and contribute $3,000 to your HSA, your taxable income drops to $47,000.

This not only reduces the amount of taxes you owe but also increases your take-home pay.

Investment options

HSAs offer an investment component that allows account holders to grow their balance over time.

Many HSA providers offer the option to invest in a variety of mutual funds or other securities.

This feature enables you to use your HSA as a long-term savings vehicle for medical expenses in retirement, similar to a 401(k) or IRA.

Disadvantages of opting for a health savings account

Despite all the benefits, HSAs are not without drawbacks. Here are a few downsides to consider before opening an account.

High deductible health plan requirement

HSAs are only available to individuals enrolled in HDHPs, which may not be the best option for everyone.

HDHPs come with higher out-of-pocket costs, and if you have recurring medical expenses or need frequent care, the higher deductibles may offset the savings from an HSA.

Penalties for non-medical withdrawals

Using HSA funds for non-medical expenses before age 65 will result in a 20% penalty, in addition to the funds being taxed as income.

This makes the HSA less flexible compared to other savings vehicles unless you strictly use it for healthcare.

Contribution limits

The IRS imposes limits on how much you can contribute to an HSA each year.

While the limits are relatively high, those with significant medical expenses may find the maximum contribution insufficient to cover their annual healthcare costs.

Now that we’ve introduced the health savings account, you can see that it’s an important tool to prevent health-related problems from impacting your financial health, and vice versa.

We hope this content has been helpful to you. Read more about finances in this post explaining how to use a digital wallet!