The Pros and Cons of Health Savings Accounts (HSAs)

As its name suggests, a health savings account (HSA) is a type of savings account you can use to pay for qualified out-of-pocket healthcare expenses including deductibles and copays.

HSAs are designed specifically to help people who have high-deductible health insurance plans (HDHPs) pay for such expenses. Consequently, not everyone can open an HSA.

Nevertheless, it's important to understand how a health savings account works as the benefits are sometimes substantial—especially for those looking to save for future healthcare expenses.

How a health savings account works

You can open an HSA account at any bank, credit union, or insurance company that offers one. If your employer offers an HSA, you can open an account directly through them.

If you open an HSA through your employer, you can make pre-tax contributions through payroll deductions (similar to a 401k). If you open an HSA on your own, you can make deposits into the account and then claim them as tax deductions come tax time. The only exception is that if you live in New Jersey or California and make payroll deductions with your employer, your contributions are taxed for state income tax purposes.

Every year, you determine the specific amount you’d like to contribute—provided that amount doesn’t exceed government-mandated limits (for 2023, $3,850 for an individual and $7,750 for family coverage). If you’re age 55 or older, you can contribute an extra $1,000 above these thresholds.

You can fund the account through a deposit, transfer, or payroll deduction and then access funds to cover qualified medical expenses using a debit card or checks to pay for qualified out-of-pocket healthcare expenses. Even if you later become ineligible for HSA contributions, you can still use the funds in your account to pay for qualified expenses.

Health savings account advantages

There are several reasons to open an HSA.

For starters, health savings accounts are generally triple-tax advantaged in that you can make pre-tax contributions (or claim tax deductions if you make after-tax contributions), and the amount in the account can grow tax-free (other than in California, New Hampshire, New Jersey, and Tennessee). You can also use the money to cover qualified expenses in the absence of taxes.

Keep in mind you don’t need to spend the balance in your HSA account every year, as any leftover money automatically rolls over to the next one. In fact, your HSA funds continue to do so on an annual basis and remain in your account indefinitely until used. When you consider that current retiree households spend almost $7,000 a year on healthcare expenses (according to the U.S. Bureau of Labor Statistics), it’s easy to see why this feature adds to the appeal of HSAs.

A health savings account is also portable, meaning that money in your HSA remains available for future qualified medical expenses even if you change health insurance plans, work for a different employer, or retire.

Anyone can contribute to your health savings account—including your parents, aunts, uncles, friends, or even strangers who decide to help you save for healthcare expenses!

Another benefit of an HSA is that you can invest the account balance in mutual funds, stocks, and/or other investment tools (choices vary by provider). While such investments can carry additional risk, these options can also help you—over time—potentially tuck away a lot more for retirement.

Health savings account drawbacks

Not everyone can open an HSA, as you must meet specific qualification requirements. For example, you must be at least 18 years of age and maintain a high-deductible health plan as your only insurance. A high-deductible plan means your health plan has a minimum annual deductible threshold of $1,500 for individuals or $3,000 for families (as of 2023). Additional prerequisites include that you cannot be enrolled in Medicare (Part A or Part B) or Medicaid to contribute to an HSA, nor can you be claimed as a dependent on someone else’s tax return. Click here to review all qualification requirements on the IRS website.

When you open an HSA, the IRS will prevent you from also having a flexible spending account (FSA). However, if your employer allows this, you can qualify for a limited-purpose FSA and in turn use this exclusively for vision and dental expenses such as dental cleanings, fillings, vision exams, contact lenses, lens solution/cleaner, and prescription glasses.

Finally, you shouldn’t contribute more than you can afford: because any amount you withdraw for non-medical purposes is subject to both income taxes and a staggering 20% penalty tax. After age 65, HSA withdrawals for non-medical uses are still subject to taxes but won’t incur a fine.

The bottom line on health savings accounts

Since some form of medical outlay is inevitable as you age, you can effectively regard an HSA as you would any other long-term savings account. For those with a high-deductible health plan, consider opening an HSA as a valuable complement to your savings strategy.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.