Pros and Cons of a Health Savings Account (and How To Qualify)

Doctor explaining pros and cons of a health savings account

How the HSA can benefit you

In this post, you’ll learn the pros and cons of a health savings account, how to qualify, and options for funding.  I’ll also talk about circumstances when the HSA is not a good option for you.

First, I’ll tell you about my own personal experience.

A few years ago we started a difficult journey through a health crisis in my family.  Mentally and emotionally it was very challenging.  I developed a whole new level of empathy for others in similar situations.

One thing (of many) I was thankful for was good insurance.  Even with a high-deductible plan, our expenses remained sustainable.

And, when medical bills started pouring in, I learned the value of a Health Savings Account.  (True confession:  I didn’t even know we had one until we needed it.)

As we sought treatments through various providers, I saw too many families get discharged from care just because their insurance ran out.  They didn’t have the money to continue the treatment they so desperately needed.

This is just one reason I think the HSA (Health Savings Account) is an excellent resource to help protect you from unexpected medical expenses.

A Health Savings Account is like a savings account for qualified medical expenses.  Similar to 401(k) savings, HSA contributions are pre-taxed and can be automatically deducted from your income.  In other words, they help lower your taxes and increase your savings, and you never miss that money because you never see it.

Your pre-taxed savings can be used for future health care costs – with no deadline or expiration.  The money remains yours even through changes in insurance, enrollment cycles, and employers.

There are qualifications you have to meet to enroll in an HSA.  In addition to the benefits, there are also some disadvantages.  Also, there are circumstances when an HSA might not be the best choice.

Keep those things in mind when reading about the pros and cons of a Health Savings Account outlined below.  But first, let’s go over what an HSA is.

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What is an HSA?

A Health Savings Account is a tax-favored account used to invest savings for future qualified health care expenses.  Think of it as an emergency fund for medical bills.

Unlike a Flexible Spending Account, you can invest your HSA savings, and you don’t have to deplete the account by the end of the year.  This means you can use an HSA as an investment vehicle that will support you into retirement.

Besides that, the tax advantages are practically unbeatable:

  • contributions are pre-taxed
  • after-tax contributions can be deducted from your gross income
  • the savings grow tax-free
  • withdrawals are not subject to federal taxes if used for qualified expenses
  • deductions lower your taxable income, which can push you into a lower tax bracket

Opening up an HSA is probably starting to sound like a no-brainer, right?  Keep reading to learn the pros and cons of a health savings account, and discover if this medical savings plan is right for you.

The pros of having an HSA

There are a few benefits I’ve already mentioned, such as the tax advantages stated above.  But there are several more great reasons to enroll in a Health Savings Account.

1. Covers out-of-pocket costs

Woman picking up prescriptions

You can use your HSA to cover out-of-pocket costs required by an HDHC, and there are many expenses that qualify.  These include deductibles, dental, vision, prescriptions, co-pays, therapies, mental health, medical equipment, hospital and lab fees, and more.  For a complete and updated list, you can visit the IRS website and read the latest version of IRS Publication 502.  (*Insurance premiums are typically not considered a qualified expense.)

2. Can be used for expenses not covered by insurance

Also, you can use your HSA funds to pay for some expenses your insurance doesn’t cover.  Depending on your healthcare benefits, there will be some costs not covered by insurance.  This could include treatments such as chiropractic, acupuncture, or fertility services.  Check IRS Publication 502 (mentioned above) for what qualifies.

3. Others can contribute

Almost anyone can contribute to your HSA.  This includes your employer, your spouse, a relative, or even a generous donor.  For individuals who file taxes, their contributions are tax-deductible on their tax returns.

4. Can be used for non-covered dependents

You can use the HSA funds for dependents not covered by insurance.  Generally speaking, qualified expenses include those not reimbursed to the account holder, spouse, and family members.

5. You never lose your savings

Any balance rolls over to the next year, so you never have to deplete the funds by a deadline.  All the savings in an HSA are yours forever – even if you switch insurance plans, change employers, retire, etc.

6. Your savings has a beneficiary

In the event of your death, you can transfer the HSA to your surviving spouse or other named beneficiary.

Keep in min, if you name someone other than your spouse as your HSA beneficiary, the account will lose its tax advantages. (*Always make sure you have completed any required beneficiary forms.)

7. Funds are easily accessible

Most HSA plans provide a debit card for convenience.  This makes it super easy to make online payments to healthcare providers.  It’s also an efficient way to keep healthcare payments separate from other budget costs.

If you happen to pay for a qualified expense from a different account, you can request a reimbursement from your HSA.

8. Number of accounts is unlimited

You can have more than one HSA.  There is no limit to how many accounts you have.  The only limit is how much you can contribute on an annual basis.

If you have more than one account, the sum total of all contributions still cannot exceed the current maximum set by the IRS.

So why would you have more than one?  One reason is due to the next benefit listed.

9. HSA funds can be invested and earn interest

One reason you might want more than one HSA account is that you can invest the funds in your HSA once you reach a minimum balance.

Different HSAs have different investment options, so you may choose to enroll in one you favor more, but still want to have an HSA through your employer because of the additional contributions your employer makes.

HSA accounts also earn interest, just like a traditional savings account.

10. No income limits

There are no income limits with an HSA.  Your annual salary does not determine whether or not you qualify.

11. No penalty for non-qualified expenses after 65

Older woman at dentist

Another benefit is that you can use HSA funds for non-qualified expenses after 65 without a penalty.  This benefit applies even if you’ve enrolled in Medicare.  (*You’ll still need to pay normal income taxes for any non-medical usage.)

12. Required HDHP will have a lower premium

As mentioned in the next section, you are required to have a high-deductible health plan (HDHP) to qualify for an HSA.  This is seen as a disadvantage by many, but the benefit is that HDHPs have lower premiums.

So, if you’re wondering how you’ll find money in your tight budget to contribute to an HSA, you can use the money you save on HDHP premiums to make your contributions.

Related Post:  Financial Peace Week 6 – The Critical Role of Insurance

The cons of having an HSA

Despite the many benefits an HSA provides, there are requirements and restrictions to be aware of.  Here are a few downsides of having an HSA.

1. An HSA requires an HDHP

You must be enrolled in a high-deductible health plan before you can qualify for a Health Savings Account.  This can result in a heavier financial burden than other healthcare plans.  This will probably be your biggest consideration when determining if an HSA is right for you.

2. Funds can only be used for qualified expenses

The savings in your HSA can only be spent on qualified medical expenses.  This generally means the expense must be used to prevent or treat a physical or mental illness.

So, for example, you can’t use the money for strictly cosmetic procedures, or over the counter personal care products like toothpaste, make-up, etc.

Any withdrawal not used for a qualified medical expense is subject to income tax and a 20% penalty, so be careful how you spend this money.

3. Your contributions are limited

Medical bill and stethoscope

Another con of the HSA is the annual, pre-tax maximum you can contribute.

For 2021, that maximum is $3,600 individual and $7,200 family.  However, if you’re over 55, you can make a catch-up contribution of up to $1,000 extra a year.

Keep in mind that these amounts include any contributions made by your employer.  Any contributions over these amounts may incur a 6% excise tax and are not tax-deductible.

4. Your contribution sources are limited

Another limitation is you can only make contributions in cash.  So, that means you can’t contribute stocks, bonds, mutual funds, property, etc.

5. You can lose the benefit of making contributions

If you discontinue enrollment in an HDHP, or if you get secondary insurance that is not an HDHP, you can no longer make contributions to your HSA.

However, the funds in the account remain yours forever and you can continue using them for qualified medical expenses.

One of the great advantages of an HSA is that you can keep your HSA funds through any circumstance and at any age.  But once you have signed up for Medicare Part A or Part B, you can no longer make new contributions.  This is because Medicare is a non-HDHP.

How do you qualify for an HSA?

There are a lot of advantages to having an HSA.  Unfortunately, not everybody qualifies to have one.

The main requirement to participate in an HSA is having a qualifying high-deductible health plan (HDHP).  What this means exactly has the potential to change from year to year, but for 2021 it means this:

a health plan with an annual deductible that is not less than $1,400 for self-coverage and $2,800 for family coverage.

If your health insurance plan has a deductible less than these amounts (depending on individual or family coverage), you are not eligible to participate in an HSA.

Also, if you do have a qualifying HDHP, the out-of-pocket amount cannot exceed a specified threshold.  Again, this amount can change in the future, but for 2021 the threshold is $7,000 for an individual plan and $14,000 for family coverage.

Here are the additional requirements for enrolling in an HSA:

  • you cannot be covered under another health plan that is not an HDHP
  • you cannot be covered under Medicare
  • you cannot be a dependent on someone else’s tax return
  • you cannot have other alternative medical savings accounts, like a Flexible Savings Account
  • you must be at least 18

HSAs are usually offered with a qualified health care plan through an employer, but there are other ways to enroll.  If you are self-employed, or are responsible for finding your own health insurance, you can enroll in an HSA through other sources.  These include banks, brokers, credit unions, and insurance companies.

How to fund your HSA

The best way to contribute to your HSA is automatically.

Piggy bank for HSA funds

You can have it deducted from your paycheck through your employer, or set up automatic transfers through your bank account.

The first option will allow you to make pre-tax contributions, so go this route if you can.  Otherwise, your after-tax contributions can be deducted from your income when you file your taxes.

Of course, you can always send a check, but this takes effort and time.  And when it comes to saving money, you may not be disciplined to spend the effort or the time.

Another way to contribute is by transferring funds from other savings accounts, like a separate HSA, or an IRA.  (*As of 2020, you cannot transfer from retirement plans like a 401(k).)

Some employers will even make contributions to your HSA.  My husband’s employer puts in a nominal amount weekly, but every little bit helps.  Check with your company’s HR department to see if you can also receive this benefit.

Video:  Rachel Cruz explains the Health Savings Account

When an HSA might not work for you

Now that you know the pros and cons of a health savings account, you need to determine if one is right for you.

Even with all the restrictions, I still think the HSA is a great financial vehicle to save money for medical expenses.  Especially because health care costs will inevitably increase, and out-of-pocket costs will likely rise due to deteriorating health as we get older.

However, there are circumstances when it’s not the best fit for your situation.

Signing up for an HSA will require you to meet a high deductible, which might be too much of a financial burden for you.  If you or anyone in your family has a chronic medical condition, you may have to pay out thousands of dollars before your coverage kicks in.  This out-of-pocket cost could limit your ability to make contributions.

Or perhaps you’re expecting high medical costs in the future, such as the birth of a child.  In this case, you may want to stick with a lower deductible.

If you feel like the risk of having to meet a high deductible outweighs the benefits of having an HSA, then it’s probably not the best option for you.

However, if you and your family are relatively healthy and rarely need medical attention, having an HSA could be a good idea.  You could get all the tax advantages that come with it, but probably won’t need to pay out the high deductible.

Or, if your income allows for a high deductible to not be a financial burden, you could use an HSA to help support your retirement expenses.

Either way, it’s worth doing some research and deciding for yourself.  Considering the average couple needs $280,000 to cover their health care expenses throughout retirement, you definitely want to have a plan for covering these costs.

Other posts you may enjoy:

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Doctor with stethoscope around neck with text overlay: The beginner's guide to the health savings account

Pros and Cons of a Health Savings Account

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