HSAs 101: What You Need to Know About How Health Savings Accounts Work

HSAs 101: What You Need to Know About How Health Savings Accounts Work

Whether we like it or not, we’re stuck in an era of rising health care costs—and even with insurance, we’re all increasingly bearing the brunt of it.

According to one study, medical costs are expected to increase by 6.5% through 2017, higher than the pace of general economic inflation. Plus, the average deductible for people with employer-provided health coverage has more than tripled over the past decade, from $303 in 2006 to $1,077 in 2015.

On top of all that, the country is dealing with extensive medical debt: A 2014 study found that medical bills were the leading cause of personal bankruptcy.

So what gives?

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You could debate for hours all the reasons that contribute to the health-related pinch to our wallets—some political, some economic, some tied to our own ailing health—but one trend seems to be holding true: More companies are increasingly offering high-deductible health plans (HDHPs) to their employees in an effort to cut back on their own overhead.

At first glance, most people tend to want to shy away from HDHPs because they're dissuaded by the high out-of-pocket costs they have to reach before their insurance kicks in. But what many workers may not realize is that HDHPs are often accompanied by a Health Savings Account (HSA), a tax-advantaged account that holds money intended to cover medical costs. HSAs can be offered through an employer, but they can also be opened by individuals who are covered by HDHPs.

“There’s no question that high-deductible plans are becoming more common,” says David Blaylock, CFP®, a financial planner with LearnVest Planning Services. “And I have a lot of clients who have been provided an HSA option through their company. They’re a little hesitant at first, but once they understand that it allows them to save in an account of their own—that’s not necessarily tied to the employer—they usually prefer that route.”

In fact, HSAs (and their linked high-deductible policies) have been growing rapidly. Devenir, a Minneapolis-based HSA investment firm, found that assets in HSA accounts surpassed $30 billion in 2015, a 25% increase over the previous year.

With open enrollment season in full swing, you may be wondering, "Is an HSA right for me?" To help you land on the answer, we've put together a 101 guide on how they work—and what makes them different from other types of savings vehicles.

The HSA Basics

Much like a 401(k) or IRA that you can use to save for retirement, an HSA is a savings account to which you contribute pre-tax dollars that earn interest or could be invested, depending on the options that are provided to you by the financial institution where you hold your account.

And much like with a 401(k), you can have your contributions taken straight from your paycheck—plus, some employers may opt to make HSA contributions on your behalf.

As is the case with retirement accounts, HSAs have contribution limits that are set by the IRS every year. For 2017, individuals who only cover themselves through an HDHP can contribute up to $3,400 per year; those on a family plan can contribute up to $6,750. If you’re 55 or older, you can also add another $1,000 as a catch-up contribution.

But here’s one big difference from a retirement account: While traditional 401(k)s, traditional IRAs and HSAs all let your earnings grow tax-deferred—which means you pay no capital gains tax—you do pay ordinary income taxes on the withdrawals you make from your IRAs and 401(k)s in retirement; plus, you could be hit with early-withdrawal penalties if you take out money prior to age 59½.

With an HSA, however, you don’t pay taxes on withdrawals, at any age, as long as you’re using them to cover qualified medical expenses—which means you can get a tax break on what you put in and get out, provided the money is being used properly.

Another pro to an HSA? That money and investment growth is all yours—there are no year-end, use-it-or-lose it or limited carryover provisions, as can be the case with flexible spending accounts.

Of course, one of the biggest limitations to an HSA is the fact that you can’t open one unless you’re enrolled in an HDHP, and for 2017 that means an insurance plan with a deductible of at least $1,300 for individuals and $2,600 for families. Another caveat: An HDHP may not be the right insurance choice if you have a long-standing illness or already know that you tend to incur high medical bills you can’t cover out-of-pocket.

“If your medical costs are low, [HSAs] enable you to set aside money to cover future health care costs and, if you stay healthy, even retirement [medical costs],” Blaylock says. “But if you have a chronic medical condition, you are probably better off in a traditional health insurance policy.”

Another important thing to note: Since HSAs are meant to be paired with an HDHP, you can’t contribute more money to them unless you are enrolled in such a plan. You can, however, keep the account open and continue to let the money grow that’s already been contributed.

Decision Time: Key Things to Look for in an HSA

As with a 401(k), you might be limited to the HSA providers that your company offers. But for those who are free to choose their own, there are a plethora of financial institutions that participate—many major banks include HSAs among their offerings.

Before you open an account, take a look at the fees you’ll be charged, suggests Blaylock, because they can vary widely from bank to bank. A comparison table at the HSA Search website shows monthly maintenance fees ranging from about $0 to $7, some of which are waived for people with higher account balances. Some providers also charge annual rather than monthly fees.

If you decide to invest your HSA funds, also consider taking a look at any additional fees that are charged by the funds that you may invest in. The higher the fees, the more you’re eating into the value of your account and offsetting your tax benefits.

Beyond fees, the HSA features you value will really depend on how you intend to utilize the account.

“If you feel like you’re going to use the account frequently, then convenience is probably going to be a big factor,” Blaylock says. “You may want to choose a bank that offers a debit card, ATM access and other easy ways to pay.”

On the flip side, if you’re viewing your HSA as more of a long-term savings vehicle, then choose a provider that offers a good mix of investment options, Blaylock adds. “You may want to go with a larger company—they’re going to have a wider range of investment choices than the local credit union.”

In fact, because of their tax benefits, some people view HSAs as another way to save for retirement. If you’re 65 and older, you can withdraw money from an HSA for any reason—even non-medical ones—but the non-medical withdrawals you make will be taxed like ordinary income, which is similar to IRA or 401(k) withdrawals that you make at age 59½ or older.

But Blaylock takes a more cautious approach. “An HSA may not be the best long-term planning tool, in my mind," he says. “It’s more about paying for health care costs in a tax-efficient way.”

With that in mind, Blaylock encourages people to put money into their HSAs until they have enough to cover their deductible. After that, he explains, “we want to make sure they’re filling other important financial buckets: emergency savings, retirement savings and college savings.”

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™  and CFP®  (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

This article was updated on September 26, 2016.

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