Editor’s Note: This story originally appeared on NewRetirement.
A Health Savings Account (HSA) is a medical savings account attached to a high-deductible health insurance plan. It can be a smart way to save money by reducing your overall medical expenses. It may also have compelling retirement benefits.
Money can be deposited into an HSA account on a pre-tax basis, just like a traditional 401(k) or IRA contribution. When withdrawing money to cover qualified medical and dental expenses, the withdrawals are tax-free.
How can an HSA save you money?
An HSA saves you money in four compelling ways.
1. HSA contributions are tax free
Contributions to your HSA are made before your income is taxed. So you will be taxed as if you were making less money. (For example, if you make $75,000 a year and invest $4,450 in an HSA, you will only be taxed $71,550.)
2. Money in an HSA grows tax-free
Any interest or investment income you earn from your HSA is tax free. You pay no taxes on account growth.
3. Payments for eligible medical expenses are tax-free
Any money you withdraw from the account to use for reimbursable medical expenses is tax-free.
4. Health plans with high deductibles are usually cheaper
Most high-deductible health plans have lower monthly premiums than other types of plans. The higher the deductible, the lower the premium. (However, these plans aren’t the best type of insurance for everyone.)
So money in an HSA is truly tax-free – you pay no tax on that money anywhere in the cycle. And you could potentially save money on a cheaper health plan.
How do you qualify for an HSA? What is High Deductible Health Insurance?
You can open an HSA if you have high-deductible health insurance.
High deductible health insurance is health insurance with minimum deductibles as defined by the IRS. For 2022 and 2023 these minimum values are:
- $1,400 for a single person in 2022 and $1,500 in 2023
- $2,800 for a family in 2022 and $3,000 in 2023
A plan with lower deductibles is not considered a high deductible by the IRS, and an HSA cannot be used with it.
A deductible is the amount of money you have to pay for your healthcare costs before your insurance company picks up the bill. After you reach your deductible, you usually have to continue paying a co-payment for services until you reach your out-of-pocket maximum.
So if you have a $2,000 deductible with a maximum of $5,000, fund your medical expenses until you’ve spent $2,000. After that, you’ll likely have a co-payment until you’ve spent $5,000.
As a rule of thumb, high deductible plans are good for people who are generally healthy. However, they can be problematic if you have a sudden and serious medical problem.
What are the contribution limits for an HSA?
The IRS also determines the amount that can be contributed to an HSA on a pre-tax basis. The year limits 2022 and 2023 are:
- $3,650 for an individual in 2022 and $3,850 in 2023
- $7,300 for families in 2022 and $7,750 in 2023
- Those age 55 or older can donate an additional $1,000
What are the maximum limits for 2022?
There are also limits on the amount of expenses, including co-insurance, co-payments and deductibles. For 2022 these are:
- $7,050 for an individual in 2022 and $7,500 in 2023
- $14,100 for a family in 2022 and $15,000 in 2023
What is the difference between an HSA and a Flexible Spending Account (FSA)?
You may also have heard of a flexible spending account (FSA).
Both the HSA and FSA are health savings accounts where your contributions are paid before tax. They also share the ability to use the funds in the account to cover qualifying medical and dental expenses on a tax-free basis.
The main difference between the two accounts is that the FSA “use it or lose it”. This means that monies donated to the FSA must be spent that year or they will be lost. Funds deposited into an HSA can be carried over from year to year, so it can be used as another retirement vehicle.
Think of an HSA as a retirement account: It’s probably the most tax-efficient way to save
HSAs have an interesting side benefit, as they are a potential source of tax-free retirement savings.
Since monies in an HSA can be carried over from one year to the next, you could carry these very tax-free monies into retirement.
An HSA is clearly the most tax-efficient investment option available. And as another retirement benefit, 72 doesn’t have minimum payouts like other types of retirement accounts.
The key to this strategy is using other means to cover medical expenses out of pocket while you work and growing HSA funds into retirement.
Many corporate HSA plans have investment options. Additionally, many banks and investment custodians offer HSA accounts with investment options similar to IRAs.
Once you retire, funds can be withdrawn from the HSA to cover a wide range of qualifying medical and dental expenses. In addition, long-term care costs and Medicare premiums are considered qualifying expenses. Any monies not used for qualifying medical expenses may be withdrawn after age 65 with no penalty. Just like an IRA, these withdrawals are subject to taxation. There is a wide range of expenses that are considered qualifying.
With the ever-increasing cost of medical care in retirement, an HSA can be a valuable addition to your retirement planning efforts.
Is an HSA right for you?
HSAs are great if you have high-deductible health insurance. If you are unsure of the implications of an HSA, you can model one as part of a NewRetirement Plan and see the tax implications. Try one scenario with HSA and another without and compare.