Everything You Need to Know About Flexible Health Savings Accounts

flexible health savings account

In March of last year, I broke my wrist while fencing with my son. Every month for 15 months, I received a bill for a medical cost related to the accident. Each time I opened the envelope, I felt grateful I could afford the costs, thanks in part to my flexible Health Savings Account (HSA).

I’m not the only person taking advantage of the HSA. According to benefits manager Benefitfocus, millennials are trying to save money on health care costs by opting for high-deductible health plans and using them in conjunction with flexible Health Savings Accounts. Benefitfocus reports that almost 40 percent of eligible millennials under the age of 26 participated in an HSA for the current year — up from less than 33 percent in 2016.

If the HSA isn’t in your financial toolbox yet, now is a good time to see if it belongs there.

What is an HSA?

The flexible Health Savings Account was introduced in 2003 as part of sweeping changes to Medicare prescription drug benefits.

It is a tax-advantaged account designed to help those with high-deductible health plans cover their out-of-pocket health costs.

The biggest perk of the HSA is the fact that you have the potential for truly tax-free savings. You receive a tax deduction for your contributions to the HSA today. Plus, when you withdraw the money later, you don’t have to pay taxes on it when you use the funds for qualified health care costs.

Another perk of the HSA is its flexibility. Unlike a more “traditional” Flexible Savings Account (FSA), all of the money in your HSA rolls over year-to-year. With the FSA, if you don’t use the money each year, you might lose some of what you’ve contributed. A recent rule change allows you to roll over up to $500 from your FSA. However, it’s still a relatively small amount when you consider you can amass thousands in your truly flexible Health Savings Account and keep all of it over subsequent years.

Your HSA can be accessed by debit card, allowing you to pay for qualified services and other costs immediately. It’s also possible to pay your health care costs out-of-pocket and then reimburse yourself from the HSA. Whether you pay with debit card or reimburse yourself, save your receipts for your tax records.

On top of all this, you can use your HSA as part of your retirement savings plan. After you reach age 65, it’s possible to withdraw money penalty-free for non-qualified expenses — just as you would with a traditional IRA.

Not just anyone can open an HSA, though.

How to qualify for an HSA

Before you decide to jump on the HSA bandwagon, it’s important to make sure you are eligible. There are no income limitations, but there are other conditions you have to meet:

You must enroll in a high-deductible health plan

First of all, you can only use an HSA if you are enrolled in a high-deductible health plan (HDHP). With an HDHP you pay a lower monthly premium, but your out-of-pocket costs are higher. The IRS determines what qualifies as an HDHP. For 2018, the HDHP minimum deductible is $1,350 for a self-only plan. A family plan needs to have a deductible of at least $2,700 to qualify as an HDHP.

On the ACA exchange, you can find silver- and bronze-level plans that qualify you for a flexible Health Savings Account. According to a Health Affairs policy brief published last year, about 25 percent of the plans on the ACA Marketplace qualified for HSAs.

There’s also a chance that your employer’s plan qualifies for an HSA. With the rise in health spending expected to outpace economic growth through 2025, it’s no surprise employers are looking to cut costs. In fact, between 2010 and 2016, deductibles increased 67 percent in the employer market.

If you choose an HDHP plan at work, your employer gets a cost break and you can increase your chances of qualifying for an HSA.

You can’t be under another health plan

If you want to enroll in an HSA, you can’t have other health coverage. This includes coverage from your spouse’s health plan and Medicare. However, you can qualify if your spouse has a non-HDHP plan, so long as it does not cover you. So if you want to open an HSA in this case, you’ll need to get separate HDHP coverage.

You can also still get an HSA if you have additional insurance coverage for accidents, disability, dental, vision, or long-term care. Exceptions for additional coverage also include workers’ compensation and coverage for specific illnesses or a fixed daily amount for hospitalization.

Someone can’t claim you as a dependent

If a parent (or someone else) claims you as a dependent on their tax forms, you can’t open an HSA. Talk to others to determine your dependent status before opening an HSA.

How to open an HSA

Before you open your HSA account, check with your employer to see if they offer an HSA.

Don’t confuse an HSA with an FSA, mentioned above — they are two different types of accounts.

Some employers offer the flexible Health Savings Account as a benefit. They can deduct your contributions from your paycheck. Some employers even match contributions you make to your employer-sponsored HSA. This can be a way to build your account using free money, similar to how you manage a 401(k).

If your employer offers HSAs, your human resources representative or plan administrator can help you fill out the paperwork to enroll.

You can also open an HSA account with your bank — many financial institutions offer them. You need to bring proof of active enrollment in a qualifying HDHP. You’ll also need identifying documents, your address, Social Security number, and date of birth, just as you would open any other financial account.

My primary banking institution holds my HSA. This makes it easy for me to transfer my contributions from my checking account into the HSA. I can also manage my HSA with ease.

Even if you hold your HSA at a bank instead of using an employer-sponsored account, it might be possible to use automatic deposits from your paycheck to fund your HSA. Check with human resources.

No matter where you keep your HSA, the money held in it is yours. If you leave an employer with an HSA, it can stay with your old company. If you want to move the money, though, check for information about rolling your account into an HSA opened at your bank or your new employer.

HSA contribution limits

While there aren’t any income limitations to using an HSA and getting the tax benefits, there are contribution limits. If you have an individual HDHP, you can contribute up to $3,450 a year in 2018. Someone with family coverage can contribute up to $6,900 a year.

Your contribution reduces your income, saving you money on your tax bill.

Using your flexible Health Savings Account

Once you fund your account, you can access the money anytime for qualified expenses. It’s even possible to invest some of the money in your HSA.

Because an HDHP often comes with a lower premium than other types of policies, you might be able to bank the savings. If your old health plan required a premium of $500 per month, but your new high-deductible plan only costs $325 a month, that’s a discount of $175. You can put that money into your HSA, saving it for future use.

Over time, if you free up more money in your budget, you can increase what you set aside each month — as long as your total contributions for the year don’t exceed the limit imposed by the IRS.

Qualified health care expenses

You can use a debit card to access your HSA, pay for your costs on your own and reimburse yourself later, or withdraw cash and use it to make qualified purchases at any time. Some of the eligible costs include:

  • Doctor visit co-pays
  • Doctor and specialist visits
  • Vision exams
  • Glasses and contacts
  • Dental exams and other dental care costs
  • Prescription medicines
  • Physical therapy
  • Hearing aids and their batteries
  • Nursing services
  • Fertility treatment

You can find a complete list of qualifying expenses with the help of Publication 502, Medical and Dental Expenses, from the IRS.

It’s important to pay attention to how you spend your HSA money and to keep good records. If you withdraw the money for non-qualified expenses, you will pay income taxes on the money. Plus, the IRS will also charge you a penalty amounting to 20 percent of the amount drawn.

You can escape the penalty once you reach age 65. However, you will still pay taxes on the amount withdrawn if you don’t use it for health care costs.

Invest some of your HSA money

Many people don’t realize that an HSA isn’t just a savings account. It’s also an investment account. Once your account balance reaches $2,000, you are eligible to invest some of the funds. Your earnings will be tax-free.

Not every account offers investment choices. Those accounts that do have this option often focus on index mutual funds and ETFs to help reduce the overall risk.

It’s important to remember that with any investment there is a risk of loss. If you choose to put a portion of your HSA into investments, you could lose those funds.

Use your HSA as part of your long-term retirement plan

While you can access your HSA money now, it’s also possible to include the account in your retirement planning. Instead of tapping your flexible Health Savings Account to pay for your out-of-pocket costs today, you can let the money grow (as long as you can afford to cover your health expenses without the HSA funds).

Consider maxing out your contributions to your HSA each year (and get the tax deduction). Once your account is eligible, start investing in funds that can help your account grow. Over time, your HSA has the potential to become a retirement health care account. Later, during retirement, you can use the funds to cover your health costs — and never pay taxes on the money.

Fidelity expects a couple to spend about $245,000 on health care during retirementWhen you consider that, building up your HSA as part of your overall retirement plan doesn’t seem like a bad idea.

Is the HSA right for everyone?

At first glance, an HSA seems like a no-brainer. However, even with all the advantages, HSAs aren’t necessarily right for everyone. The main issue is the requirement to enroll in a high-deductible health plan.

Depending on your health needs, an HDHP might not be the best choice for you. If you have young dependents requiring a lot of doctor visits, you could easily spend a lot in out-of-pocket costs and be unable to set aside money in your HSA.

Similarly, a high-deductible plan might not be best if you have a chronic condition that requires regular treatment or expensive medications.

Run the numbers

Before choosing a plan, estimate what your likely health care needs will be.

For years, an HDHP worked for me. I rarely reach my deductible, I almost never go to the doctor beyond my annual checkup, and I have only one recurring prescription that costs me nothing. Until I broke my wrist, I didn’t have major medical costs. Those years of saving on premiums benefitted me.

But if I’d had larger health care needs, the story would have been different.

Say you have a condition that requires four checkups throughout the year, with each specialist visit costing $250. On top of that, you need a prescription that costs $300 a month.

What if you have a “regular” plan that costs $500 per month, with a $30 specialist copay and a $15 prescription copay? In this case, with your insurance premiums, monthly drug copay, and the quarterly visits, your total spent comes to $6,300 for the year (see chart below).

flexible health savings account

But what about the HDHP? You only pay $325 per month, but you have a $2,600 deductible. After that, you’re responsible for 20 percent of your health care costs.

After seven months, when you’ve had two specialist visits and seven filled prescriptions, you’ll just barely be hitting your deductible. For the remainder of the year, you only pay 20 percent for your services, which will include two more specialist visits left ($100) and five months’ worth of prescriptions ($300).

When you include your premiums for the year, your total with the HDHP comes out to $6,900. Because of your recurring health care needs, choosing the higher-deductible plan sets you back an extra $600 a year.

Ask for more options

Check your health care choices during your employer’s open enrollment. Look for a plan that fits your budget and your needs.

If your employer doesn’t offer an HDHP option, but you think it’s right for you, talk to your human resources representative about adding that choice. Additionally, if your employer offers an HDHP and you want to take advantage of the lower premiums, find out if there is an HSA. Encourage your employer to offer an HSA if they offer HDHPs.

Health care prices are likely to keep rising. Consider your budget, and research health plans. If you qualify, and if the numbers make sense for your situation, an HSA might be one way for you to manage your long-term health costs.

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