How Does an HSA Work? How to Enroll, Contribute and Spend

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How does an HSA work? If you’re looking to learn how to enroll in, contribute to, and spend your Health Savings Account (HSA), you’ve come to the right place.

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How does an HSA work? If you’re looking to learn how to enroll, contribute, and spend your Health Savings Account (HSA), you’ve come to the right place. Need to know the basics? Check out our post “What is an HSA?” to get all the info. Once you’re ready for some details about how exactly an HSA works, read on.

HSA Defined

HSA stands for Health Savings Account. An HSA is a personal savings account that lets you set aside money pre-tax to use for qualified health expenses. HSAs are interest-bearing, which means you get paid interest on how much money you have in your account. Plus, your HSA funds grow tax free.

That’s good news because once you have an HSA, you get to keep it even if you change jobs. That makes HSAs a great way to save money for healthcare expenses as you get older.

So how much can you put in your HSA? That’s up to the IRS. The IRS sets annual contribution limits, so you can only contribute as much as they allow. The contribution limit changes each year, and once you turn 55, you can contribute an extra $1,000.

However, once you are 65 and enroll in Medicare, you cannot keep contributing to your HSA. But the good news is that you can continue using your HSA funds for the rest of your life.

How to Enroll in an HSA

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To enroll in an HSA, you have to also enroll in a High-Deductible Health Plan (HDHP). High Deductible Health Plans are health plans with lower premiums and higher deductibles. The IRS sets out guidelines each year to determine what qualifies as an HSA-eligible High Deductible Plan.

An HSA can help you with some of the costs of having a higher deductible, but it’s also a long-term way to save money for medical expenses. If you don’t have an HDHP, but still want to save funds tax-free for healthcare expenses, you may want to consider a Healthcare FSA.

If your employer offers an HSA alongside your HDHP, you can enroll with them. During the enrollment process, you will choose how much you want to contribute monthly to your HSA for the year. The contributions will be deducted from each paycheck. You’ll also get instructions on how to use your new account.

If your employer doesn’t offer an HSA, or you bought your health insurance plan on the private market, don't worry. You can open an HSA independent from your employer. If you choose to contribute pre-tax, you will have to coordinate with your HR team.

How to Add Money to Your HSA

Annual Contribution Limits

There are a few different ways to contribute to your HSA. No matter which method you use, remember there are annual contribution limits. In 2020 that is $3,550 for an individual under 55.

For someone who has family coverage with their HDHP, that limit increases to $7,100.

If you’re 55 and older, you can also make a catch-up contribution. The IRS decides how much that additional amount can be, and in 2020 and 2021, it is $1,000. You can add a catch-up contribution to your regular contributions or make it a one-time thing.

How Funds Are Contributed to an HSA

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There are five different types of contributions that are important to know about:

  • Payroll Contributions: This is a convenient way to contribute, but it does require an employer-sponsored HSA. First, you set your annual contribution amount upon enrollment. Then the pre-tax funds are deducted from your paycheck via payroll and deposited into your HSA.
  • Individual Recurring Contribution: This method is an option for someone who does not have an HSA with an employer. In this case, your contributions are withdrawn from your bank account. Only your employer can deduct pre-tax money (via payroll), so these funds will be contributed post-tax. But because HSA contributions are considered to be pre-tax, whatever amount you contribute will be tax-deductible. So make sure you take note of that for your tax return.
  • Employer Contributions: If you’re lucky, your employer may also make contributions to your HSA. These contributions are also pre-tax, so they don’t impact your taxable income. It’s essential to know how much your employer is contributing so you can adjust your contributions. Both contributions combined from you and your employer still can’t go over the IRS annual contribution limit.
  • One Time Contributions: Whether you have an employer-sponsored plan or a private one, you can also make one time contributions to your HSA. One time contributions are what they sound like—you contribute a lump sum whenever you decide. This may be a good option if you expect to have a significant medical expense.
  • Third Party Contributions: Your family or friends (or anyone else) may also contribute to your HSA. Maybe you have a parent who generously wants to help you save for retirement. Or a close friend who wants to contribute to your medical expenses. Whatever the situation may be, anyone is welcome to contribute funds to your HSA.

How to Spend Your HSA

There are many ways to use the money in your HSA for qualified healthcare expenses. Exactly how you use it will depend on the rules set out by your plan administrator. Here are some of the common methods used to spend HSA funds:

  1. Debit card: Most HSA platforms provide individuals with a debit card to quickly and easily pay for qualified health expenses.
  2. Receipt upload or reimbursement: It's important to always save your receipts. If you make a qualified expense without your HSA debit card, you can ask for reimbursement for the out-of-pocket expense. Make sure to save your receipts so you can substantiate any expenses later.
  3. Save the funds for later: One of the major advantages of HSAs is that they are personal accounts that stay with you as you age. Medical costs often grow as we age, making an HSA a valuable retirement planning tool. You can contribute funds until you are 65, but you can only use them for qualified medical expenses. If you use them for anything else, you can incur a 20% tax penalty.

Once you are 65 and enrolled in Medicare, you can use the funds for healthcare expenses OR anything you want. If you want to get a triple tax benefit, you will still need to use the funds for qualified healthcare expenses, as these are never taxed through an HSA. If you use the funds for something else, they are only subject to regular income taxes (like a Traditional IRA). There’s no penalty like when you are under the age of 65.

Remember, HSAs do not have a "use it or lose it" policy like FSAs. So don’t feel pressured to use your funds within the year. You own your HSA account and can take it with you when you change jobs or HSA providers.

The Long Term Value of an HSA

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HSAs are a fantastic retirement planning tool because they are triple tax advantaged. This refers to the three ways they are tax-free:

  • You make pre-tax (or tax-deductible) contributions
  • The money grows interest tax-free
  • You can make tax-free distributions for qualified healthcare expenses.

Another big benefit is that you can invest the money in your HSA, so it has the potential to grow even more over time. Many people who invest their HSA do so in mutual funds, just like a traditional IRA. We recommend talking to your tax advisor to see what the best plan is for your situation. Overall, HSAs are a great way to save some money, reduce health care costs, and plan for the future.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

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