What is a Health Savings Account?

Health Savings Accounts (or HSAs for short) crept into our lives in 2003. While HSAs are often misunderstood, they’re an incredibly powerful tool for you as a taxpayer. Perhaps even epic. 

With this tool, Congress gave us something that I believe is the best deal we have gotten from Washington in a long, long time. Certainly in my lifetime!

HSAs have financial benefits worth your side-eye consideration, including tax advantages and potential health cost savings for families. But first, let’s start with training wheels. 

What is a Health Savings Account (HSA)?

An HSA is a special kind of money stash that gives individuals and families with high-deductible health insurance plans a way to save for their medical expenses, with tax benefits attached. It allows individuals to make HSA contributions up to $3,650 ($7,300 for family coverage) per year (even more if you’re over 55!), and when they do so, they get a tax deduction on that year’s tax return. 

Here’s the beauty of HSA funds: as long as the money remains in your HSA, it grows tax free. When the funds are taken out of the investment for medical reasons, they come out tax free as well. 

Did you catch that? 

• Money goes into your HSA? You don’t pay taxes. 
• Money grows in your HSA? It’s tax free.  
• Money is taken out of your HSA for medical expenses? You don’t pay taxes! 

HSAs are triple tax advantaged. Say that one three times fast! I’m telling you, there’s nothing else like it.

Don’t I Get a Tax Deduction for Medical Expenses Anyway?

Yes, medical expenses can be tax deductions…but that’s subject to three big “ifs.” 

1. You plan on itemizing. (Fewer and fewer people itemize these days now that the standard deduction is so high). 
2. Your medical expenses exceed 7.5% of your Adjusted Gross Income (AGI). Then, if you do itemize, you can only deduct your medical expenses that exceed 7.5% of your Adjusted Gross Income (AGI). 
3. Your medical expenses exceed 7.5% of your AGI by a decent amount. (You can only deduct medical expenses that are above and beyond the 7.5% of your adjusted gross income). 

Let’s illustrate:

• If you make $80,000 this year, your medical expenses need to exceed $6,000 (80,000 x .075). 
• Let’s say it was a tough year of doctor visits and hospital bills, and you end up paying $7,000 in medical expenses. 
• On your taxes, you would only be able to deduct $1,000 ($7,000-$6,000) (and you would need to itemize). 

Translation, please! Medical expenses are generally only tax deductible if they’re qualified, itemized, and hefty enough to exceed 7.5% of your income. 

Another Benefit of an HSA: Double up Your Tax Benefits!

If you open an HSA and fund it throughout the year, you’ll automatically get the benefits of a tax deduction. As a hypothetical: Say you already know you have a $1,000 medical bill coming. You can contribute $1,000 to your HSA, then use your HSA to pay the bill the next day. Just by doing so, you’ll get the deduction. However, in doing it this way, you’re only taking advantage of one of the tax benefits.

If you have the money, an even better way would be to fully fund an HSA each year and pay for medical expenses out-of-pocket. Then, you would get the deduction for the HSA and get the itemized deduction for medical expenses (subject to the “ifs” mentioned above). The money in the HSA would grow tax free. Then, when you need it for medical expenses you can’t as easily afford in the future, it would come out of the account tax free as well. 

Pro tip: Double the deductions while you are in need of them, and then get the money tax free in the future when your income is lower (such as in retirement).

Is It Worth Having a High Deductible Health Plan in Order to Have an HSA?

It depends on your unique situation, though often the answer is yes! I have spent many, many hours analyzing health insurance options for myself and my clients. I look through 100+ options for a person or family, taking into account the premium, deductible, co-insurance payments, etc. When all costs are considered together, higher deductible plans work out to be the better deal almost every time. 

I've found that HSA plans on their own are often the best deal in health insurance. When you add in the tax benefits, they are even harder to beat.

Health Savings Accounts Have Some Other Great Tax Advantages

For those in the higher tax brackets, as well as those who are eligible for employer retirement plans, there is an additional bonus for opening an HSA. 

As you probably already know, your ability to contribute to an IRA or Roth IRA is phased out and then eliminated at certain income levels. There is no income limitation on eligibility to contribute to an HSA. This is a way that you could contribute to something much better than an IRA even when you can’t contribute to a Traditional or Roth IRA because of your income. 

Also, with many retirement accounts, you are required to begin withdrawing funds (and being taxed on them) once you reach 72. With an HSA, you can leave the money growing in the account until you need it.

What if I Need My HSA Funds for Something Else?

The answer to this question depends on your age. 

If you pull money out of your HSA for non-medical reasons before you turn 65 years old, you have to pay income tax plus a 20% penalty. Ouch! But after you turn 65, the penalty goes away. Withdraw away! At that point, if you use the money for non-medical purposes, you would pay taxes on that money (but not if it’s used for medical expenses!). 

Some Nuts & Bolts About HSAs

In order to take advantage of this opportunity, you must first have a “High Deductible Health Plan” (as defined by Congress). Also, you (and your spouse) must not be eligible for employer sponsored health insurance (unless the employer offers an HSA plan). 

The easiest way to know if a health plan meets the definition of “high deductible” is to ask the insurance company or agent. Every company that I am aware of offers at least one (and usually several) HSA-eligible plans, and usually it is indicated in the name of the plan.

How Do I Set Up an HSA?

If your employer offers an HSA plan, they will typically give you a recommendation for an HSA provider or have a pre-existing arrangement with an insurance company.

If you don’t have an HSA available through your employer, you can optionally register for one on your own.  There are tons of insurance companies and HSA options out there—I suggest working with your financial advisor or using an HSA provider search tool to find the right fit for your unique healthcare needs.

Once you have established the account, you’ll be issued a debit card that makes it easy to spend the money in your HSA (just don’t accidentally use it to buy gas or groceries)! 

Wouldn’t it be awesome to have a green thumb…but for money? Here’s one final amazing feature of HSA: there are ways you can help your HSA funds grow! One financial institution that I know of actually offers six types of investments for the funds—anything from a money market account to 100% stock mutual funds. So, if you feel pretty confident that the money you’re putting into your HSA will be there for a long time before you need it, you would be able to invest it a little more aggressively and make it grow.

Is It a Good Idea to Open an HSA?

I get it. Figuring out what in tarnation an HSA is and whether it’s beneficial to you can be confusing. Plus, not everyone has time for (or interest in) sifting through the entire IRS Publication 969 that details health plans. Here’s to you for doing your research! 

I often tell my clients to think of an HSA as a gift to your future self. For most people, making small HSA contributions over time will pay off in the long run…especially in your later years, when you may have higher medical care costs. 

It’s hard to find ways to let your money grow tax free, and this could be one of them! Don’t let the phrase “high-deductible” scare you off before you talk to your employer or financial advisor about the sizable tax benefits of an HSA. 

HSAs are just one piece of the tax puzzle. Use these YNAB tips and tricks to make your tax prep and filing a breeze.

Casey Murdock is a financial adviser serving clients in multiple states. He brings a strong technical expertise to the YNAB blog, and he found Jesse a steal of a deal on life insurance back in the day.