Health Savings Accounts Explained
Al Waller: Health Savings Accounts or HSAs are now quite common in the health care landscape. As a matter of fact, Devenir Research estimates there were more than 31 million of these accounts in 2021. Employers commonly provide them as part of their health care insurance suite of offerings – and they often offer incentives to help people save for health care costs.
Welcome back to ClearPath – Your Roadmap to Health & Wealth SM. I'm your host Al Waller. With us today is Catherine Collinson, CEO and president of nonprofit Transamerica Institute® to explain these accounts.
Catherine, it’s nice to have you back.
Catherine Collinson: Hey Al, it's great to be back.
Al Waller: Could you start off by helping us get a better understanding of what HSAs are?
Catherine Collinson: Sure, as you said HSAs are Health Savings Accounts – they are just that. What's more, HSAs are a tax-advantaged way to pay for current medical expenses, as well as save for future medical expenses. In order to be eligible to open an HSA and to save into it, you must be enrolled in what's called an HSA-eligible health plan or what's commonly known as a high-deductible health plan.
Al Waller: I remember doing an episode with Mihaela last fall on the many types of benefits employers offer, which included various types of health care insurance. Could you remind our listeners what a high-deductible health plan is?
Catherine Collinson: High-deductible health plans by definition, have higher deductibles than traditional insurance plans – meaning that you pay more out-of-pocket health care costs yourself before the insurance kicks in and starts to pay its part of the health care costs.
However, it's really important to note – high-deductible plans do cover preventative care before the deductible is met. The appeal of high-deductible plans is they typically have lower monthly premiums than traditional health care plans. To help people save for these higher deductibles, Congress created HSAs or Health Savings Accounts.
Al Waller: I believe you also mentioned there are some tax advantages associated with HSAs. What would they be and how do they work?
Catherine Collinson: HSAs offer a triple tax benefit – not 1…not 2…but 3 major tax benefits. Let me walk you through each of these tax benefits.
The first tax benefit is they are tax deductible – meaning that contributions into HSAs are typically made with pre-tax dollars through payroll deduction. So, they're not included in your income tax when you file your federal tax returns, although they may be included in state income taxes.
The second tax benefit is tax-free growth – meaning, unlike regular savings or investment accounts, the interest or capital gains within your HSA are not taxed.
Then the third and final tax benefit for HSAs is tax-free withdrawals – what that means is withdrawals that are used to pay for qualified medical expenses do not incur income taxes.
Let me spell this out for you. You can save in an HSA and deduct that from your income, and then that savings can grow. Then later when you incur an expense for a qualified medical expense, you can make that withdrawal from the account and not pay taxes on it. In fact, you never pay federal income taxes on those dollars.
Al Waller: That's fantastic. I must say I really like the sound of that. It almost sounds too good to be true. Now, hypothetically, let's say someone wanted to put their entire paycheck into an HSA to haul in these substantial tax breaks. Could they get away with something like that?
Catherine Collinson: Well Al, the IRS is not that generous. There are annual limits to what you can save into the HSA.
For 2022, the annual contribution limit is $3,650 for those with individual health care plans and $7,300 for family plans. However, there is a little bit of good news for those age 55 or older. The IRS has what's called, catch-up contributions.
If you are 55 or older, you can save an additional $1,000 annually into the HSA – and in many cases, if both spouses in a married couple are 55 or older, they can make additional contributions depending on the specifics of their health plan. I want to make a comment about the contribution limits. The limits that I just described come from all sources – from the account holder or employee, an employer, or someone else who makes a contribution to the HSA.
Al Waller: You just mentioned employers contributing. How does all of that work?
Catherine Collinson: Great question, Al. It varies by employer. Of course, an employer has to offer a high-deductible health plan to their employees, and then as part of that would offer the HSAs.
Many employers actually sweeten the HSA by making contributions to it on the employee's behalf. Some just make a set dollar contribution to encourage employees to sign up for the HSA and start saving in it. Other employers may use incentives for employees to entice them to engage in healthier behaviors and when they do, the employer would make a contribution.
For example, some employers will make a contribution to the HSA when an employee gets their annual health screening. The employer may offer incentive programs such as weight loss – you achieve a certain weight loss goal, and they'll make a contribution to your HSA. Employers even have things like walking challenges that if you walk a set distance within a set period of time, they'll make a contribution into your HSA.
Al Waller: I think that's all very affirming – using more of the carrot versus the stick approach here. That's good news. Now we see how people and their employers can build up these accounts.
I'd like to turn your attention to how folks can use their money in their HSA's. First, what are considered “qualified medical expenses”?
Catherine Collinson: This is very, very important. What is a “qualified medical expense”? For most people, the qualified medical expenses are their annual deductible, co-pays, and prescriptions.
However, there's a host of items that meet the requirements of qualified medical expenses that people may not be aware of – that includes the costs of things like eyeglasses and contact lenses, over-the-counter medications, thermometers and blood pressure monitors, even feminine hygiene products, and sunscreen. With the pandemic, the government also added COVID-related items as qualified medical expenses, including personal protective equipment and home testing.
I also want to highlight, there are HSA stores – some of which are connected with HSA providers. Major drug store chains have set them up within their online websites – and the world's largest online retailer also has an HSA store within its website.
Al Waller: It sounds like there are a lot of products out there that do fall into the list – I actually had no idea there were HSA stores out there. That should really help eliminate the guesswork of which products are in and which ones are out. What other features should we be aware of in order to take full advantage of these savings?
Catherine Collinson: One thing that's really important to know is HSAs are “portable”, meaning the accounts are in your name. For example, you're with an employer, you've saved in an HSA, and you're leaving your employer – that account is in your name. You may be able to keep the account with the current HSA provider or you could roll it over into a new HSA provider. The important thing for you to know though – it's yours.
The second thing that's really important is many people confuse HSAs with FSAs or Flexible Spending Accounts. Flexible Spending Accounts require that you use or lose the amount you've saved each year. HSAs are not that way. As we've been talking about, you contribute to the HSA and then use that HSA for qualified medical expenses or you can choose to just let that savings grow within the account over time, which leads to the last point I want to share as we're talking about this.
Most HSA providers have an option for you to invest your savings in things like mutual funds, stocks, and bonds after you reach a certain account balance. The threshold varies – but in some cases that goes as low as a $1,000 account balance. If you so choose, you have the ability to invest according to whatever menu of investment options that they have available. Research shows us very few people are actually taking advantage of this opportunity.
Al Waller: I still have to say, the portability feature sounds like a really attractive feature and incentive to get people to do that, especially if they're planning a move down the road and can take that with them.
What other guidelines or restrictions should we be aware of in connection with HSAs?
Catherine Collinson: One big rule to be aware of – because it could prove costly – is taking withdrawals from HSAs for non-qualified medical expenses. We've talked a lot about qualified medical expenses. What happens if you use a portion of your HSA on expenses that do not meet that definition of qualified medical expense? The reality is two-fold. One, you will pay income taxes on that amount.
The second is, if you are under age 65 and do so, there will also be a 20% penalty on the amount withdrawn. If you do it, there's a price to pay. I will point out that at 65 you do have the ability to withdraw from HSAs for non-medical expenses without the penalty. However, you will still incur your regular income tax.
Al Waller: Well, I think most would agree that HSAs offer some surprising benefits and when you think about it, really are investing vehicles more people should be aware of and utilizing.
As always, Catherine great to have you with us.
We hope you'll join us for future episodes. Also, in case you missed it check out our previous episodes on Employee Assistance Programs Explained and getting good sleep for good health.
ClearPath – Your Roadmap to Health & Wealth is brought to you by Transamerica Institute, a nonprofit private foundation dedicated to identifying, researching, and educating the public about retirement security and the intersections of health and financial well-being.
You can find our weekly podcast on WYPR’s website and mobile app, wherever you get your podcasts, and at transamericainstitute.org.
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Until the next time, I’m your host Al Waller. Stay safe, be well and thanks for listening.
ClearPath – Your Roadmap to Health & Wealth is produced by the Transamerica Institute with assistance from WYPR.
The information provided here is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical, or financial advice or guidance.
