Our healthcare system is complicated. That’s why most of us are overwhelmed when trying to buy health insurance.
Often times, the easiest way to handle the confusing world of deductibles, coinsurance, copayments, out-of-pocket maximums and pre-existing conditions is to throw up your hands and take the cheapest insurance plan offered by your employer.
Unfortunately, that’s also the worst way to do it.
Finding the best plan for your family and budget requires a great deal of work. But you may never consider one of the most valuable assets of the healthcare program: a health savings account, commonly known as an HSA.
Many people haven’t heard of HSAs, and don’t understand the many powerful financial benefits they provide in terms of healthcare.
Let’s jump into a crash course (it’s quick, I promise).
What is an HSA?
Before understanding what an HSA is, it’s important to know what it’s not.
- An HSA is NOT health insurance
- You don’t pay premiums for a health savings account
- Your HSA does NOT directly reimburse your doctor, hospital or pharmacy
- A health insurance account doesn’t carry limitations like deductibles or co-pays
In short, even when you have an HSA, you will still need a traditional health insurance plan.
Then what is a health savings account?
The best way to think of an HSA is like a bank account (like the one you’d have at a savings bank or credit union) which can be used to pay your qualified medical expenses. (We discuss the “qualified” part later.)
There are a number of differences between a traditional savings account and a health savings account, but here’s the most important difference: when you open an HSA account, you’re eligible for huge, triple-tax benefits that you can’t receive from a regular savings account.
Here’s another big difference: an HSA allows you to invest that tax-advantaged money for big gains over the long-term, just like a 401K. If you do things right, an HSA can function like an additional retirement account, allowing you to save even more than you could with just a 401K or similar plan.
Your money is safe in a health savings account; your account is FDIC-insured (if you’re not investing it), just like a bank account would be.
Here’s another way of looking at it: A health savings account lets you accumulate money in advance, specifically to pay for health care expenses in the future. If you don’t spend down your balance, you can grow your HSA funds year after year, with major tax advantages to save for the future.
How to Open and Fund an HSA
You can open a health savings account almost anywhere that handles financial transactions like banks, credit unions and insurance agencies – and through other reputable services that exist specifically to serve HSA clients, such as Lively.
Once you have your HSA, you can add money to it in several different ways:
- Many employers will deduct your regular contributions directly from your paycheck. If you fund a health savings account this way, the money goes into the HSA before taxes are withheld, meaning you don’t pay any taxes on your HSA contributions.
- If your employer doesn’t offer that option, you can have contributions withdrawn from your checking account on a regular basis. That money isn’t deposited pre-tax, naturally, but you can then deduct all HSA contributions on your income tax return each year.
- The third way you can add money to an HSA is by writing a check or making an online deposit whenever you want to make a contribution. Again, the money you put into your health savings account can be deducted when you file your income tax forms.
Now that you have an HSA with money in it, what do you do?
Using Your HSA
The stated purpose of a health savings account is to let you save tax-advantaged money to pay for qualified health expenses. Using it for that purpose couldn’t be simpler.
When you open your HSA you’ll receive a debit card linked to the account. The debit card can be used at your doctor’s office, at the drugstore, at the dentist, or anywhere else you receive health care services. You can use the HSA to pay pills you receive after a visit or reimburse yourself for medical expenses you paid for out-of-pocket.
Here’s the best part:
The money you take out of your HSA for qualified expenses are tax-free withdrawals. You didn’t pay tax on the money when it went into your account – and you don’t pay tax on the money when you take it out to pay medical bills.
We haven’t even gotten to the third part of “triple-tax benefits” yet. You get those if you use your HSA as a long-term retirement savings vehicle.
Investing Through Your HSA
You never know when unexpected medical expenses may hit. If they do, having money that you’ve saved in your HSA can be a life-saver – literally. If you don’t need to access those funds to pay your medical bills, though, you can fully profit from the third, powerful tax benefit of health savings accounts.
There’s no requirement that you withdraw money from your HSA at any time, so you can let it sit in the account and build value. You can also invest the money in a number of ways: stocks, bonds, CDs, mutual funds or ETFs.
Your health savings account investment earnings accumulate tax-deferred, year after year.
If you decide to withdraw them to pay medical expenses they become tax-free. That’s the triple-tax benefit of a health savings account. The money goes in tax-free, it grows tax-free inside the account, and withdrawals for qualified expenses are tax-free.
There’s one more subject we haven’t mentioned yet:
What happens when you withdraw the retirement nest egg you’ve built up in your HSA over your lifetime? As you might expect, there’s a price for taking money out of your account for non-qualified spending. You’ll pay a 20 percent penalty on the withdrawal, plus normal income tax on the amount you take out before the age of 65.
However, once you reach age 65, that penalty goes away. You can use the money in your HSA for anything you’d like, just like you can with an IRA or a 401K. All you have to do is pay income tax on the amount you withdraw, as you would with any other retirement account.
So here’s the bottom line:
You can put money into an HSA, invest it, and save for retirement – all tax-free until you take it out. Since there are limits on how much you can put into an IRA or 401K each year, the HSA is an additional method you can use to save for retirement. That money belongs to you; it doesn’t go away at year’s end, or when you change employers.
Pretty cool, huh?
What’s the Catch?
Health savings accounts are federally-regulated, so you know there have to be rules and restrictions to be aware of.
Here are the most important stipulations:
- You must have a high-deductible health plan (HDHP) in order to set up and use an HSA. These plans have lower monthly premiums than most types of health coverage, but their deductibles are quite high (as you’d guess from their name). To qualify as an HDHP in 2019, an individual plan must have a deductible of at least $1,350 and an out-of-pocket maximum no higher than $6,750. For family plans, the 2019 limits are a minimum of $2,700 deductible and a $13,500 maximum for out-of-pocket expenses.
- There are limits on how much you can put into an HSA every year. For 2019, HSA contribution limits are $3,500 for an individual, $7,000 for a family. If your employer also contributes to your HSA, that money counts against your limits. Those aged 55 and older can add an additional $1,000 per year as a “catch-up” contribution.
- You can only spend your HSA funds on “qualified medical expenses.” This includes charges from doctors, dentists, optometrists and hospitals (except for cosmetic procedures), prescription medications (some over-the-counter medications require a letter of medical necessity from your doctor), prescribed medical equipment, and other services such as acupuncture, smoking cessation programs and pregnancy tests. You can’t use an HSA to pay for health club memberships, daycare or your health insurance premiums. You can see exactly what you can purchase with Lively’s eligibility search tool.
Best HSA Providers
There are thousands of health savings account providers, and you should choose between them according to how you expect to use your HSA.
If you’re going to use your account just to pay medical bills on an annual basis, you don’t really have to be concerned with the types of investment options the HSA offers or the interest your account earns. The money won’t be in your account long enough to invest it or earn much interest. Instead, look for reputable financial institutions that don’t charge fees and/or don’t require a minimum balance in your HSA, and ones which issue checks and debit cards as payment options.
On the other hand, if you plan to carry over balances from year to year and plan to use your health savings account to save for retirement (or for catastrophic medical expenses down the road), your selection criteria for an HSA provider should be different. The best providers will offer many diverse investment options, the ability to invest in no-fee products, options for automatic monthly investment and an easy-to-use online user interface.
The HSA provider which has taken the industry by storm is Lively, because it offers all of those features. The interface is user-friendly, accounts are free, no minimum cash balance is required, and all accounts are FDIC-insured.
Most importantly, though, Lively offers every HSA-account holder its own TD Ameritrade self-directed investment account. Investment options include stocks and bonds, CDs, more than 13,000 mutual funds, and more than 500 commission-free ETFs – all easily managed online. It’s the least-expensive, most-robust way to build a health savings account that’s available for unforeseen medical emergencies while taking advantage of the HSA’s triple-tax advantage to save for retirement.
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.