What Is an HSA and Why Do You Need One?

Jessica Moore

Sun, Aug 8, 2021, 6:00 AM 4 min read

If you qualify, a health savings account could help you to offset the cost of healthcare. An HSA provides a triple tax break — you can contribute to it with pre-tax income, your savings grow tax-free, and you can use funds for qualified medical expenses tax-free.

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In addition to the triple tax break, contributions to an HSA don’t expire. You can keep the account through retirement and use it as an extra savings account.

Below, let’s go over what a health savings account is and how it works.

What Is a Health Savings Account?

Also called an HSA, a health savings account is a type of tax-free savings account. It helps qualified individuals to cover the cost of medical care. Not only do you put pre-tax money into an HSA, but you can also make tax-free withdrawals — so long as you use the funds for qualified medical expenses.

Who Can Get an HSA?

You must have a high deductible health plan. HDHPs come with lower monthly premiums, but they also require that you pay more out of pocket. The combination of an HSA and an HDHP can help you to save money on healthcare costs.

Good To Know

How Does an HSA Work?

With an HSA, you have two options. One is an employer-sponsored account, which you contribute to with pre-tax income. Your other option is an individual HSA. With this type of account, you contribute with post-tax money — but your contributions are tax-deductible.

Contribute to your HSA through payroll deductions, making online transfers, or submitting a check. To access your HSA, you can use an HSA debit card or a check connected to your HSA account. You may also reimburse yourself for qualified out-of-pocket expenses using an online transfer.

What Should You Remember About HSAs?

While you don’t need authorization from the IRS to open an HSA, there are still some rules. First, you must have an HDHP to qualify. For 2021, that means a health plan with a $1,400 deductible for individuals and $2,800 for families. There are some other things to keep in mind with an HSA, as discussed below.

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Contribution Limits and Excesses

Those with self-only coverage under an HDPD can contribute a maximum of $3,600 to their HSA. Those with family coverage can contribute up to $7,200. If you have an employer-sponsored HSA, your employer may match your contributions. Those contributions do count toward your maximum limits.

If you contribute more than the maximum amount allowed based on your plan, the excess amount may be subject to a 6% excise tax. You may withdraw some of your excess contributions and avoid paying the excise tax if you meet specific IRS requirements.

Withdrawals and Taxes

When you use HSA for qualified medical expenses, those withdrawals are tax-free. You can use the money for your medical care or the medical care of a spouse or dependent children included on your tax return.

Any withdrawals for non-qualified expenses aren’t tax-free. If you use the funds in your account for anything that doesn’t qualify, those withdrawals are subject to a 20% tax penalty. If you’re over the age of 65, though, that penalty doesn’t apply.

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How Do You Establish an HSA?

You need to enroll in an HDHP first, then open an HSA. You have a few options:

Ask your bank.
Look for HSA providers online.
Talk to your health insurance provider.

Compare HSA provider options. Different providers may have varying methods for making deposits.

What Are the Benefits and Disadvantages of an HSA?

Here are the pros:

If you change jobs, you can take your HSA with you.
You don’t pay taxes on the money you contribute, and you can withdraw funds tax-free for qualified medical expenses.
Your employer can contribute to your account.
Your funds roll over each year.
Your HSA can double as an extra retirement fund.

Here are the cons:

Withdrawals for non-medical and non-qualified medical expenses are subject to a 20% tax penalty.
You may have to pay fees, such as maintenance fees, for your account.
You need an eligible HDHP to qualify.
Your contributions may not cover all of your medical expenses.

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