2020 Guide to Using an HSA for Savings, Tax Breaks, and More

A health savings account (HSA) is a wise way to cut taxes and save for the future. This complete guide will help you start an HSA and use it to your financial advantage.

Laura Adams, MBA
7-minute read
Episode #645
The Quick And Dirty

If you're eligible for a health savings account (HSA), it's a wise way to cut taxes and save for the future. The CARES Act expanded the types of products and services you can purchase using an HSA in 2020. Don’t miss the opportunity to purchase many new allowable expenses for less using an HSA.

One of my favorite tax-advantaged savings accounts is a health savings account or HSA. Not only does an HSA allow you to pay less tax for a wide variety of allowable medical expenses, but you can spend it any way you like in retirement. It’s a legal way to pay less tax and save more for the future.

But having an HSA comes with strict rules for saving and spending the funds. This post will cover how to use an HSA wisely, seven significant benefits they offer, and updates on new (and often surprising) allowable expenses in 2020.

What is a health savings account (HSA)?

An HSA is a tax-exempt account for the sole purpose of paying allowable medical expenses. But to qualify for one, you must first have a particular type of health insurance, which I’ll cover in a moment.

It’s a legal way to pay less tax and save more for the future.

You can contribute to an HSA if you get health insurance as an individual or through a group plan. You always own and manage an HSA as an individual, and there are no income limits to qualify.

You don’t need permission from an employer or the IRS to set up an HSA, and it stays with you even if you change jobs or become unemployed. Even if you lose your insurance, you can continue spending your HSA balance; however, you may not be 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 be invested for potential growth in a menu of available options, such as mutual funds. And when you take distributions to pay for qualified medical expenses, your original contributions plus any earnings are entirely tax-free.

Contributions to an HSA can come from you, someone else, or an employer.

Contributions to an HSA can come from you, someone else, or an employer. Some company benefits include regular deposits into an HSA, such as $150 a quarter. Like with matching funds for a retirement plan (such as 401k or 403b), HSA contributions from an employer are not included in your taxable income, a fantastic benefit!

Depending on your income tax rate, using an HSA to pay for allowable medical expenses 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. You can only use HSA funds to pay for current or future qualified, unreimbursed medical expenses. Taking ineligible distributions 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 arrangement (FSA). However, it can only be offered by an employer and funded through payroll deductions on a pre-tax basis. It comes with an annual use-it-or-lose-it policy.

With an HSA, there’s no deadline to spend your balance. Funds can stay in the account indefinitely.

With an HSA, there’s no deadline to spend your balance. Funds can stay in the account indefinitely, even if you change your insurance company, become uninsured, or are unemployed.

So, don't confuse these two accounts. 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 special type of health insurance to qualify for an HSA. It’s called a high deductible health plan (HDHP). A deductible is an amount you must pay for covered medical expenses before your benefits begin each year.

While you might think that 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 generally makes the other go down.

More employers are offering HDHPs to help workers keep premiums as low as possible. No matter if 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!

But remember that a high deductible health plan isn’t the right choice for everyone. These plans work best 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 2020, you can contribute up to $3,550 to an HSA when you have insurance for yourself only, or up to $7,100 when you have a family plan. If you're over 55, you can contribute an additional $1,000 when you have either an individual or a family health plan.

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-medical expenses without paying the 20% penalty. However, you still must 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 medical expenses.

Which expenses are HSA-allowable in 2020?

Once you've opened an HSA and have a balance, understanding how to spend it is critical. Allowable expenses include a wide range of medical costs you might incur until you meet your annual deductible or that simply 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, and I’ll cover ten of them in a moment.

The new CARES Act expands eligible expenses—here are some new products and services you can pay for using an HSA:

  • Feminine hygiene 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.

10 surprising HSA-qualified medical expenses

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

1. Prescription sunglasses

Paying for an annual eye exam and new prescription sunglasses. Of course, regular prescription eyeglasses and contact lenses are also qualified expenses.

2. 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.

3. 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 treatment that’s purely cosmetic.

4. Chiropractic

All chiropractic care is HSA-qualified, even if your insurance plan doesn't cover it. Don't hesitate to seek it as an alternative for pain relief before you go for medication or surgery.

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 birth control, 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.

8. Care from a psychologist or psychiatrist

Costs to support yourself or a family member through the treatment of a mental condition or illness is HSA-qualified. You can use HSA funds to pay for a patient’s treatment at a health institute if treatment is prescribed by a physician to alleviate a physical or mental disability or illness.

9. Home improvements

Any special equipment or improvements installed in a home to care for you or your 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 type of medical care, whether 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 are recommended as part of treatment. 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 include out-of-pocket costs, including gas, oil, tolls, and parking fees, as HSA-qualified. However, you can't cover general vehicle maintenance or insurance costs.

What Are the Tax Benefits of Using an HSA?

There are three tax benefits you get from an HSA that aren’t available with any other tax-advantaged account.

  • 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 $8,100 and cut your taxable income for 2020 by that amount.
  • 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.
  • Withdrawals from an HSA used for qualified healthcare expenses are entirely tax-free.

7 major benefits of an HSA

To sum up, here are seven significant benefits of having an HSA:

  1. Contributions are tax-deductible up to the annual legal limit, which reduces your taxable income.
  2. Funds remain in the account from year to year for your entire life, with no penalty if you don’t spend them.
  3. Withdrawals are never taxed if you spend them on qualified medical expenses.
  4. Your balance grows tax-free when you have interest earnings or investment gains if you spend them on qualified medical expenses.
  5. Funds can be used for you, your family, or your dependents for qualified, out-of-pocket, medical expenses.
  6. You own the account and decide how much to save or spend each year. An HSA is portable, so if you change employers, switch health plans, or become unemployed, it’s yours to keep.
  7. 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 from your IRA into an HSA 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, brokerages, and specialty institutions. Most are convenient to use and offer paper checks, a debit card, and online banking.

To quickly review the health savings account rules, download the free HSA Cheat Sheet. This one-page guide summarizes the updated requirements 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.