Weighing the Pros and Cons of an HSA

With a health savings account, commonly called an HSA, you can set aside pre-tax funds to pay for future medical expenses. While an HSA sounds like a no-brainer, reviewing the benefits and possible drawbacks of these types of accounts can help you make the best decision for your finances. Here's what you need to know about HSAs to make an informed choice.

Advantages of an HSA

With an HSA, you make pre-tax contributions, which can help you reduce your total income tax liability. The funds in the HSA grow tax-free until you withdraw them to pay for eligible health expenses, including but not limited to doctor visits, copayments, medications and treatments.

The wide range of qualifying medical and dental costs is another key benefit of an HSA account. For a full list, refer to IRS Publication 502. 

You decide how much money to contribute to your HSA. You must have a high-deductible health plan to enroll in an HSA. Your employer may set up this account on your behalf with your HDHP or you can set up a separate account. Others can even contribute to your HSA; for example, your spouse can add funds or your employer can make a contribution as an employee benefit. 

If you don't spend everything in your HSA, the funds roll over to the next year. This sets the HSA apart from a flexible spending account, in which you lose any money you don't use by the end of the tax year. 

Most HSA plans allow you to invest in stocks, bonds, mutual funds and other financial vehicles. That means you can potentially grow funds set aside for health care far beyond the return from a traditional savings account. To take advantage of this benefit, look for an HSA custodian that offers investment services. 

An HSA is also "portable," which means you can transfer it from one job to the next if you decide to move on from your current employer. You can also keep your HSA if you decide to change your health insurance provider. 

Many HSA fans also appreciate the ease of use of this type of account. Setting up an HSA is as easy as setting up a savings account once you select a bank that offers this service. You will receive checks or a debit card so you can pay directly for your medical costs.

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Downsides of an HSA

As mentioned above, you aren't eligible for an HSA unless you also have an HDHP. This type of health plan requires you to meet a deductible before your coverage begins of at least $1,400 for a single person and $2,800 for a family. HDHPs also have a capped out-of-pocket cost of $7,000 for an individual and $14,000 to cover the entire family. The IRS updates these limits every year. 

The IRS also establishes annual contribution limits for HSAs. Individuals can put up to $3,600 in this type of account in 2021 and families can contribute up to $7,200. If you are age 55 or older, you can contribute up to $4,600 for this tax year. 

If you have reached age 65, you can no longer contribute money to an HSA since you receive health coverage through Medicare. However, you can keep using the remaining funds in an existing HSA to pay for your qualifying health expenses. 

Another potential downside? You cannot use HSA funds to pay for health insurance premiums. 

To sum up, if you have an HDHP, an HSA can be a smart way to save for future health expenses while reducing your tax burden. Those who have other types of health plans must consider alternative options such as flexible spending accounts to cover medical expenses.