Health Savings Accounts, or HSAs, are medical savings accounts that are available to people enrolled in high-deductible health plans (HDHPs). HSAs are considered tax advantaged because deposits made to these accounts are exempt from federal income tax. The funds in HSAs will also grow, tax-free, “rolling over” to accumulate year to year (unlike Flexible Spending Accounts or FSAs, which require most—if not all–of the funds to be used before the end of the plan year).
Perhaps the most attractive benefit of HSAs is that the account holder can make tax-free withdrawals for qualified medical expenses at any time. Once you turn 65, you’ll also be able to use those funds to cover other expenses without paying the standard 20% penalty (though you will be responsible for the regular income taxes on those funds).
Am I eligible for an HSA?
In order to qualify for an HSA, you must be covered by a high-deductible health plan. You must also ensure that you are not enrolled in any other non-HDHP insurance. You can also lose your eligibility for an HSA if you have coverage from a Flexible Spending Account (FSA) or a Health Reimbursement Arrangement (HRA) through your employer or spouse.
If you are already enrolled in Medicare, you are not eligible to begin or make contributions to an HSA. If you were already enrolled in the HSA prior to signing up for Medicare, you can still withdraw funds from your existing account.
Contributing funds to an HSA
Making contributions to your HSA is as easy as making deposits to your regular savings account. You can ask your employer to contribute a set amount to your HSA via automatic deductions from each of your regular paychecks, or you can log in to your online account to make one-time or recurring deposits.
While you are likely to be the primary contributor to your HSA, other people, like your employer, a family member, or a generous friend or anonymous do-gooder, can also make deposits to your account just as you would to a regular savings account. It is important to remember, however, that there is a limit to the amount of money that can be contributed, in total, to the account each year, regardless of who is making the deposits.
There is one notable exception to this rule: If you start or become eligible for an HSA account later in life, you do have the opportunity to deposit an additional $1,000 each year after you turn 55 via “catch-up” contributions. If your spouse is also 55 or older, they may establish their own HSA and make “catch-up” contributions to that separate account.
Withdrawing funds for qualified medical expenses
The funds contributed to an HSA can be used to cover qualified medical expenses at any time without penalties or federal tax liability. There is also no “approval process” or gatekeeper involved when you use the funds in your HSA to cover qualified medical costs, which puts you in the driver’s seat when it comes to the important decisions around your health care.
What are qualified medical expenses?
In general, any costs related to preventing or alleviating a physical or mental illness is considered a qualified medical expense. The IRS provides a current list of these qualified expenses, as well as a list of ineligible expenses, in Publication 502, which is updated on a yearly basis.
As you’ll see, the range of covered expenses is fairly comprehensive, including everything from artificial limbs and teeth to wheelchairs, nursing services, and psychiatric care. You can also pay some Medicare premiums with these funds. Other health-related expenses that are not considered qualified medical expenses include hair transplants, weight-loss programs, and cosmetic surgery.
Withdrawing funds for non-medical expenses
Once you turn 65, you will also be able to use these funds to cover non-medical expenses without penalties, though you will have to pay income taxes on those withdrawals.
If you decide to withdraw funds from your HSA for non-qualified medical expenses prior to turning 65, you will face a 20% penalty in addition to the regular income tax rate.
HSAs as retirement investment accounts
Because HSAs have multiple tax advantages, and because funds withdrawn from an HSA for non-medical expenses after age 65 are taxed at your current income tax rate (just as they would be in a traditional IRA), many people have begun using their HSAs as a retirement account to cover other expenditures.
However, because HSAs enable account owners to make tax-free withdrawals on qualified medical expenses, which are likely to increase as you get older and face new health issues, in general, HSAs are most valuable if used as they were originally intended—to maximize health care savings—rather than as a replacement for a more traditional retirement fund.
How do HSAs fit with other aspects of my retirement plan?
If you are enrolled in a HDHP and are eligible to contribute to an HSA, you’ll want to maximize your contributions before you turn 65 and become eligible for Medicare. While you can delay your enrollment in Medicare without penalty and continue contributing to your HSA if you continue to work past age 65, your contributions will no longer be tax deductible.