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Your Guide to Saving Money with an HSA Now and in Retirement

If you're looking for a clever way to cut taxes, pay less for healthcare, and build retirement savings, a health savings account (HSA) delivers. Laura's guide will help you start an HSA, understand the rules, and use it to your financial advantage.

By
Laura Adams, MBA
8-minute read
Episode #701
The Quick And Dirty

If you're eligible for a health savings account (HSA), it's a terrific way to save money now and accumulate wealth for the future—if you understand the rules. Last year, the CARES Act expanded the types of products and services you can purchase using an HSA. Don't miss the opportunity to save on many new allowable expenses using this tax-advantaged account.

One of my favorite tax-advantaged accounts is a health savings account, or HSA, for short. Not only does an HSA allow you to pay for a wide variety of healthcare expenses with pre-tax dollars, but you can spend it any way you want after your 65th birthday. It's a clever, legal way to pay less tax, save more, and invest for the future.

All that said, having an HSA comes with strict rules you must follow or pay a hefty penalty. This post will cover terrific tax benefits you get from an HSA, updates on new (and often surprising) allowable expenses, and tips for using an HSA to build wealth for retirement. 

What is a health savings account (HSA)?

An HSA is a tax-free account for the sole purpose of paying allowable healthcare expenses. But to qualify, you must have a particular type of health insurance, which I'll cover in a moment (see "Who qualifies for an HSA?" below).

You can contribute to an HSA if you purchase an HSA-eligible health plan on your own or through an employer's group plan. You always own and manage an HSA as an individual, and there are no income limits to qualify.

In other words, you don't need permission from an employer or the IRS to set up an HSA, and it stays with you if you change jobs or become unemployed. Even if you lose your HSA-eligible insurance, you can continue spending your HSA balance, but you're not eligible to make any new contributions to the account.

The beauty of an HSA is that contributions are deductible on your tax return even if you don't itemize deductions. The funds can earn interest, or you can invest some or all of them for potential growth in a menu of options, such as mutual funds. The investment options depend on your HSA provider, so it makes sense to shop around before setting up an HSA. Then, when you take distributions to pay for qualified medical expenses, your original contributions plus any earnings are entirely tax-free.

Depending on your income tax rate, using an HSA to pay for allowable healthcare expenses on a tax-free basis means getting about a 20% to 30% discount. Over your lifetime, that can add up to huge savings!

Contributions to an HSA can come from you or someone else, such as a family member or employer. Some company benefits include regular deposits into an HSA, similar to matching funds for a retirement plan. Any HSA contributions from an employer don't get included in your taxable income, which is a fantastic benefit!

Depending on your income tax rate, using an HSA to pay for allowable healthcare expenses on a tax-free basis means getting about a 20% to 30% discount. Over your lifetime, that can add up to huge savings!

However, similar to a retirement account, you should never put money in an HSA that you might need for everyday expenses. Until you turn 65, you can only use HSA funds to pay for current or future qualified, unreimbursed medical expenses, or you're subject to penalties. Pulling money from an HSA to spend on non-qualified expenses, such as groceries, clothes, or a vacation, means you must pay income tax plus an additional 20% penalty on withdrawn amounts.

What's the difference between an HSA and an FSA?

Another popular medical savings account is a flexible spending account (FSA). However, it can only be offered by an employer and funded through payroll deductions on a pre-tax basis. An FSA has an annual use-it-or-lose-it policy, but with an HSA, there's no deadline to spend your balance. Funds can stay in an HSA indefinitely, even if you change your insurance company, become uninsured, or are unemployed.

In short, don't confuse these two accounts. They might sound similar, but they have some key differences. Individuals can open an HSA, and it permits tax-deductible contributions with no spending deadline. An FSA can only be offered in the workplace, and you must spend all or most of your balance every calendar year.

Who qualifies for an HSA?

I mentioned that you need a particular type of health insurance to qualify for an HSA. Only those with a high deductible health plan (HDHP) are eligible to open an HSA. As a reminder, the deductible is the amount you must pay out-of-pocket for covered medical expenses before your benefits begin each year.

While you might think it's better to have a lower deductible and pay less out-of-pocket, having a higher deductible reduces your monthly insurance premiums. Deductibles and premiums have a seesaw relationship because increasing one makes the other go down.

No matter whether you get health insurance on your own or through work, find out if it's an HSA-qualified plan so you can get all the medical savings possible!

More employers are offering HDHPs to help workers keep premiums as low as possible. No matter whether you get health insurance on your own or through work, find out if it's an HSA-qualified plan so you can get all the medical savings possible!

The current IRS rule for HDHPs says the minimum annual deductible for in-network care is $1,400 and the maximum for the annual deductible and other out-of-pocket expenses is $7,000. That applies if you purchase health insurance just for yourself. And if you have a family plan, the minimum deductible is $2,800, and the maximum out-of-pocket is $14,000. The IRS allows HDHPs to offer preventive care with no deductible.

Having an HSA-eligible health plan means you could have high out-of-pocket costs. So, they're not the right choice for everyone. In general, they're excellent coverage when you're in relatively good health and aren't likely to spend the full deductible each year.

How much can you contribute to an HSA?

For 2021, you can contribute up to $3,600 to an HSA when you have an individual health plan or up to $7,200 with a family plan. If you're over 55, you can contribute an additional $1,000 with either type.

For 2022, the HSA contribution limit for individual insurance increases slightly to $3,650, and the family plan cap goes up to $7,300. You can make tax-deductible contributions anytime during the year, even up to April 15 for the previous tax year. But you're never required to make contributions to an HSA.

How can you use an HSA in retirement?

An often-forgotten benefit is that after age 65, you can spend HSA funds on non-qualified expenses without paying the 20% penalty. Be advised, though, that you'll still have to pay income tax on those amounts.

That means an HSA turns into something similar to a traditional retirement account if you keep it long enough. That's a great reason to max it out every year, even if you don't expect many healthcare expenses. And it makes the account worth hanging onto even if you leave an HDHP and can no longer make contributions. 

What are HSA-qualified medical expenses?

Once you've opened an HSA and have a balance, understanding how to spend it is critical. Qualified expenses include a wide range of health costs you might incur until you meet your annual deductible or that just aren't covered by your health plan.

The IRS says for an expense to be HSA-qualified, it must pay for healthcare services, equipment, or medications. There are many covered expenses that you might not expect.

10 surprising HSA-qualified medical expenses

There are hundreds of potential HSA-qualified medical expenses, and you can see the complete list in IRS Publication 502, Medical and Dental Expenses. Here are ten qualified medical expenses that may surprise you:

1. Chiropractic care

All chiropractic care is HSA-qualified, even if your insurance plan doesn't cover it. That means you can explore this alternative for pain relief before you go for medication or surgery.

2. Birth control

If your doctor prescribes your birth control pills, you can use your HSA to pay for them. 

3. Eye surgery

Any costs you might have to pay out-of-pocket for surgery to correct your vision, such as LASIK or the removal of cataracts, can be paid for using HSA funds. And if your sight or hearing is impaired, you can also use it to purchase and care for a guide dog or other service animal.

4. Dental care

Going to the dentist is also covered for routine cleanings and the prevention of dental disease. You can use your HSA for services such as fluoride treatments, X-rays, fillings, extractions, dentures, and braces. Teeth whitening is not a qualified expense, nor is any cost or therapy that's purely cosmetic. Although some might consider them primarily cosmetic, artificial teeth are an HSA-eligible expense. 

5. Acupuncture

Even if your health insurance doesn't cover acupuncture, you could use your HSA to pay for it tax-free.

6. Fertility enhancement

You can use an HSA to pay for any treatment to overcome an inability to have children, such as in vitro fertilization. Once you're a parent, you can also spend it on breast pumps and supplies that assist lactation. Or you can use an HSA to go in the opposite direction and pay for sterilization or legal abortion.

7. Drug and alcohol addiction treatment

Any amount you pay for yourself or a family member to have inpatient treatment at a drug rehabilitation center, including meals and lodging, is HSA-qualified. You can also pay for transportation to and from Alcoholics Anonymous meetings in your community, assuming a medical provider has deemed AA attendance medically necessary for you.

8. Care from a psychologist or psychiatrist

You can use HSA funds for the costs to support yourself or a family member who you claim as a dependent through the treatment of a mental condition or illness. You can use HSA funds to pay for a patient's treatment at a health institute if a physician prescribes treatment to alleviate a physical or mental disability or illness.

9. Home improvements

Any special equipment or improvements installed in a home to care for yourself or your dependent family members can be paid for with an HSA if their purpose is medical care. These might include constructing entrance ramps, widening doorways, installing lifts, or lowering cabinets and sinks. Another capital expense that's HSA-qualified is removing lead-based paint in a home you own or rent.

10. Transportation and travel

Costs to get to and from any medical care, such as on a bus, taxi, train, plane, or ambulance, can be paid for with HSA money. This rule includes making regular visits to see an ill family member if visits get recommended as part of treatment (e.g., if you're the parent of a sick child and need to visit them at their treatment facility). You can include lodging, but not meals when you travel to another city for medical purposes.

If you use your vehicle to get to medical services, you can use HSA money to cover certain out-of-pocket costs, including gas, oil, tolls, and parking fees. You can't cover general vehicle maintenance or insurance costs, though.

It's also worth noting that in March 2020, the CARES Act expanded eligible HSA expenses. Here are new products and services you can pay for using an HSA:

  • Menstrual care products, such as tampons, sanitary napkins, and menstrual cups.

  • Over-the-counter medications, such as cold and flu medicine, pain relievers, sleep aids, eye drops, and remedies for indigestion, acne, and motion sickness.

  • Telehealth services through the end of 2021.

Additionally, HDHPs can have a $0 deductible for telehealth services, just like for preventive care. 

What are the tax benefits of using an HSA?

With an HSA, you get three tax benefits. That's a significant advantage that doesn't come with any other tax-advantaged account.

  1. If you're eligible to contribute to an HSA, your contributions are tax-deductible up to your annual limit. For instance, if you're over 55 and have family coverage, you could contribute up to $8,200 and cut your taxable income for 2021 by that amount.

  2. While your money is in an HSA, it grows tax-deferred. You don't have to pay annual taxes on interest income or investment earnings in the account.

  3. Withdrawals from an HSA used for qualified healthcare expenses are entirely tax-free.

Are there more HSA advantages?

In addition to its terrific tax benefits, using an HSA gives you the following advantages:

  • Funds remain in the account from year to year for your entire life, with no penalty if you don't spend them.

  • Funds can be used for you, your spouse, or your dependents for qualified, out-of-pocket medical expenses.

  • You own the account and decide how much to save or spend each year. 

  • It's portable, so if you change employers, switch health plans, or become unemployed, it's yours to keep.

  • You can fund an HSA for the first time using the money you've already saved in an IRA by doing a tax-free rollover once in your lifetime, up to the annual contribution limit.

How do you open and fund an HSA?

If you qualify for an HSA, they're available at many banks, credit unions, and financial institutions. They're convenient to use and offer paper checks, debit cards, and online banking. You can use an HSA provider recommended by your employer, choose your own, or transfer funds to a different institution as you wish.

To quickly review the updated HSA rules, download my free HSA Cheat Sheet. This one-page guide summarizes what you need to know and some of the best places to open your HSA.

About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.