How Does a Health Savings Account Work?
By Dan Nastou, CFA
A Health Savings Account, or HSA for short, can be a great way to save money, invest for retirement, and cover future medical expenses all at the same time. But there are some things you should know about them before signing up.
Here’s what we cover
What is an HSA
Key benefits of an HSA
Who qualifies for an HSA
How to set up an HSA
Key Takeaway
What is an HSA?
An HSA is a type of savings account where you’re allowed to contribute pre-tax money, let it grow tax free, and then use it to pay for certain qualified medical expenses.
Eligible expenses generally cover a wide range of categories – including doctor visits, medications, surgeries, X-rays and MRI scans, medical devices, physical therapy, psychiatric care, and even vision and dental expenses, to name just a few.
You can’t use it for things like vitamins or vacations (no matter what it does for your health) or to pay your insurance premiums, typically.
Feel free to check out the IRS website for more details on what is/isn’t covered.
Key benefits of an HSA
There are a few reasons why opening an HSA can be a good idea.
• Medical care can get really expensive, especially if you have a high deductible insurance policy (who the HSA was designed for). Saving up in advance can make a big difference when the time comes and you need the money.
• The tax benefit will grow your savings faster. You contribute pre-tax money, your account is allowed to grow tax-free, and if you take the money out for qualified expenses, you won’t have to pay any taxes. This can give your savings a huge boost over time.
• You can invest your HSA savings in stocks, bonds, and funds. This allows you to earn a return on your money. Eventually you can use the money for non-medical expenses once you turn 65 (after paying taxes). So HSAs can double as a way to cover medical expenses and as a way to save for retirement, similar to a dedicated retirement account.
• You can take your HSA with you if you leave your employer. You can also roll your balance from one year to the next (unlike a Flexible Spending Account, or FSA, which must be spent).
Who qualifies for an HSA
In order to qualify to open an HSA, you need to have a high-deductible health insurance plan (HDHP), which is defined by the government as a plan with an annual deductible of at least $1,500 and an out-of-pocket maximum of $7,500 for an individual. For a family, it’s an annual deductible of at least $3,000 and an out-of-pocket maximum of $15,000. (Amounts as of 2023).
Quick Reminder: The deductible is the amount you’re on the hook to pay before your insurance coverage kicks in. And the out-of-pocket maximum is the most you can be on the hook to pay in a single year.
You also can’t qualify for an HSA if someone claims you as a dependent on their tax return or if you’re currently on Medicare.
How to set up an HSA
Setting up an HSA is pretty easy to do. For starters, some employers offer them as a workplace benefit, so check to see if yours does.
Even if your employer doesn’t offer one, you can still set one up on your own. Many financial institutions offer them. So a quick internet search will provide several form which to choose.
When you’re comparing options, pay attention to fees and the various features they offers.
Decide on your contribution amount
When you set up your account, you’ll have to decide on your contribution amount. You can contribute up to maximums set by the government ($3,850 for an individual and $7,750 for a family plan, as of 2023).
You can contribute money in several ways;
-Automatic deductions from your paycheck
-Automatic transfers from a bank account
-Manual transfers whenever you want
Some employers will even contribute money to HSAs. So if you’re lucky enough to have that as an option, make sure you take advantage.
Selecting your investments
In addition to deciding on your contribution amount, you can also select which investments you want to hold in your account.
We won’t get into all the details here, but in general, you’ll want to look for low-fee funds that offer a diversified range of investments.
We cover investing in more detail in our Core Content, starting with the basics. Or you can check out our investing cheat sheet for a big picture investing overview.
Key Takeaway
Health Savings Accounts offer a tax-efficient way to save for future medical expenses while also growing your retirement savings. How quickly your HSA grows will depend on a few factors, like how much you contribute, how often you take money out, and what return you earn on your money. But overall, it can be a great way to protect your finances while building wealth.
This is intended for educational purposes, not financial advice. Talk to your financial professional if you need help or are thinking about making changes to your investments.
Looking for more?
Opening an Individual Retirement Account (IRA)
