Surprise health expenses can ambush you. So, investing in a health savings account (HSA) to prepare for your future health needs can be a smart decision.
An HSA can save you when medical costs arise, and there are many tax advantages. But an HSA isn’t the right choice for everyone.
Here’s how to decide if a health savings account is right for you.
What is a health savings account?
A health savings account allows you to stash money for future medical expenditures. It’s available only if you’re enrolled in a high-deductible health plan (HDHP), and it can provide a valuable layer of additional financial protection.
Your contributions are tax-deductible, and if the HSA is offered by your employer, the money can come right out of your paycheck. The balance rolls over each year; it isn’t a use-it-or-lose-it policy like a flexible spending account.
You’ll usually receive a debit card that’s linked to your account, which you can use for qualifying medical expenses, including deductibles, copays, coinsurance, eyeglasses, and prescription medication.
If you change employers or insurers, you can take the policy with you — just like a 401(k).
3 pros of a health savings account
To find out if a health savings account is right for you, check out some of the benefits.
1. You’ll receive baller tax benefits
Health savings accounts have a trifecta of tax benefits: You can deduct contributions from your income, your money grows tax-free, and you don’t pay taxes on withdrawals for health expenses.
Even better, HSA payroll contributions aren’t subject to the Federal Contributions Insurance Act (FICA) — the 7.65 percent tax you pay for Social Security and Medicare.
“One of the major benefits of the HSA is the tax-deferred growth and tax-free distributions if proceeds are used for qualified medical expenses,” one financial planner told MarketWatch. “Even after you leave employment, funds left in your HSA can be used to pay for medical expenses throughout retirement.”
You’d have to pay taxes only if you withdrew the money for nonqualified expenses.
2. Your money will grow
Unlike saving for future health needs in a savings account, saving in an HSA allows you to invest your money in low-cost mutual funds.
Although that’s riskier than a traditional savings account, it could lead to higher returns. And because you’re not required to spend the money each year, you can let it grow as long as you’re able to do so.
3. Other people can contribute
The funding of your health savings account isn’t limited to you. Anyone can contribute: your spouse, your parent, etc. — but most commonly, it’s your employer.
Among companies that offer an HSA match, the average contribution is $491 per year, according to the Society for Human Resource Management (SHRM). It might not seem like a lot, but over time, it could add up.
If your employer contributed $491 annually for 30 years and you earned a 7 percent return, you’d have $49,626 toward health care by the time you retired.
3 cons of a health savings account
There are also some drawbacks of health savings accounts you should consider. Here are a few.
1. You’ll have high deductibles
Even if you have money in a health savings account, the high deductibles on your HDHP can make medical care an expensive prospect.
That could convince you to bypass care to save money — which will almost always end up costing you more in the end.
2. You could pay penalties
As the name suggests, the funds from a health savings account must be used for medical expenses.
If you choose to withdraw money for a different purpose, you’ll pay taxes on the amount — plus a 20 percent penalty. After age 65, you’ll pay taxes but not the penalty on nonqualified withdrawals.
3. You could pay fees
Depending on where you open your health savings account, you could face maintenance fees of up to $4.50 per month.
“Account maintenance fees are the most important factor in choosing an HSA if you plan on using it as a spending vehicle,” one Morningstar analyst told CNBC. “Because interest rates are low, maintenance fees have a much larger impact on balances than rates for the average account holder.”
Some institutions waive the fees if you carry a minimum balance (anywhere from $1,000 to $5,000), so keep an eye out as you search for accounts.
Who can open a health savings account?
You can open a health savings account only if you’re enrolled in an HDHP, which is a plan with a deductible of at least $1,350 for an individual or $2,700 for a family, according to SHRM.
Though HDHPs have lower monthly premiums, the higher deductibles mean you’ll pay more out of pocket when you need care — up to a maximum of $6,650 per individual or $13,300 per family each year.
The money from a health savings account can help cover those costs. (But you should note that certain preventative screenings and checkups remain free under HDHPs.)
As for contribution limits, individuals can save up to $3,450 per year in a health savings account, while families can save up to $6,900 per year. If you’re over 55, you can contribute an additional $1,000 per year. After age 65, you can use the money in your account but can no longer contribute.
How to open a health savings account
If you’d like to open a health savings account, you must first ensure you’re enrolled in an HDHP. If you don’t know, contact your health insurer to double-check.
To find a health savings account, you can ask your insurer, employer, or bank, or you can compare plans online using HSA Search. Don’t enroll in the first plan you find; make sure you like the investment options, customer service, and fees.
Or try a startup like Lively, which has no minimum balance and no fees for its basic account. If you’d like to invest your money in low-cost mutual funds, it charges $2.50 per month.
Should you open a health savings account?
Health savings accounts are a great way to save for future medical expenses tax-free — and they can be a valuable asset in retirement.
So, if you can afford to pay for your current medical expenses out of pocket and let the money in your health savings account grow until you retire, it can be a smart strategy.
But if you anticipate needing a significant amount of medical care in the years before you retire, a regular plan with a lower deductible might be a better fit.
Carefully weigh the costs and benefits before making a decision, as few things are more important than your health.
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