Money Girl's Quick and Dirty Tips for a Richer Life

How to Maximize Your Health Savings Account (HSA) Benefits

Episode Summary

I’ll review how to know if your health plan qualifies for an HSA and strategies to maximize its benefits.

Episode Notes

Laura answers a listener question about knowing whether buying HSA-qualified health insurance can pay off. Find out what makes a plan eligible and wise strategies for maximizing an HSA.

Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.

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Episode Transcription

Katya S. says, I've been investigating HSAs and found that you must have a high-deductible health plan (HDHP) with maximum out-of-pocket expenses of $7,050 to qualify. For the past few years, my policy has had a deductible and out-of-pocket max of $8,150, making it ineligible for an HSA.

I never reach my deductible because I don't visit doctors much. But if I switch to an HDHP that’s HSA-approved, my premium would go up over $800 a year. How can I know if paying more for a health plan that qualifies for an HSA would be worthwhile?”

Katya, thank you for the great question! I’m sure many people in the Money Girl audience are wondering the same thing, and this episode will give you an answer. Plus, I’ll review how to know if your health plan qualifies for an HSA and strategies to maximize its benefits.

Hello, friends, and thanks for joining me this week! My name is Laura Adams, and I'm a personal finance expert who's been hosting the Money Girl Podcast since 2008. I'm also the author of several books, including my most recent title, which was a No. 1 Amazon New Release, called Money-Smart Solopreneur–A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. If you're building a business or want to earn more income, I hope you'll grab a copy of the paperback, ebook, or audiobook today!

And if you're on the socials, be sure to connect with me on Twitter @lauraadams or Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.

My mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress. If you're enjoying Money Girl, take a moment to let us know you're getting value from each weekly episode by rating and reviewing the show in your podcast app!

OK, let’s start by reviewing what an HSA is.

What Is a Health Savings Account (HSA)?

HSAs were created in 2003 to help Americans manage and reduce rising healthcare costs. It’s one of my favorite tax-advantaged accounts because it allows you to cut medical costs, eliminate taxes, and invest your balance for growth.

I call HSAs a triple threat because they provide three significant tax advantages:

1. Your HSA contributions are never taxed. 

An HSA gets funded with pre-tax dollars, whether you or someone else (such as an employer or family member) makes them on your behalf. The money you put in the account is tax-deductible, reducing your taxable income, even if you don’t itemize deductions on your tax return.

You can make HSA contributions at any time, even up to April 15 for the previous tax year–but you’re never required to make them. And you can contribute even if you’re retired, unemployed, or have an annual income less than your contributions. However, once you enroll in Medicare or can be claimed as someone’s tax dependent, you can’t make HSA contributions.

2. Your HSA earnings are never taxed.

Similar to bank savings, most HSAs pay interest. However, you typically can also choose from a menu of investment options, similar to a retirement account. You can transfer all or a portion of your HSA to various mutual funds or exchange-traded funds (ETFs) to grow your balance.

But unlike a taxable bank account or brokerage account, your interest and investment growth in an HSA is entirely tax-free!

3. Your HSA withdrawals are never taxed.

When you take money out of an HSA to pay qualified healthcare expenses, which I’ll cover in a moment, there are no taxes. Your original contributions and earnings are entirely tax-free. That’s even better than a traditional retirement account, which defers taxes until you make withdrawals.

So, the triple tax advantage of an HSA means your contributions, earnings, and withdrawals for qualified healthcare expenses are tax-free. Pretty sweet! \

Which Health Plans Are HSA-Qualified?

While the HSA benefits are excellent, not everyone can cash in. You can only have an HSA when you also have a qualifying high-deductible health plan.

As the name indicates, an HDHP has a relatively higher annual deductible. Compared to other plans, they charge lower monthly premiums because your coverage doesn’t begin until you’ve paid more out-of-pocket.

However, HDHPs cover specific preventive care at no charge, such as annual physicals, prenatal and well-child care, immunizations, and screenings, regardless of the deductible. That means some basic medical costs get automatically covered, even if you haven’t met your annual deductible. So having a higher deductible doesn’t necessarily mean you must skip important checkups if your budget is tight.

Knowing if your HDHP is HSA-qualified gets tricky because not all health plans with high deductibles are eligible. They must meet the following criteria:

In other words, the definition of an HDHP for HSA purposes extends beyond just its deductible amount. And as Katya mentioned, even health plans with higher out-of-pocket costs, such as hers, may not be HSA-eligible. Unfortunately, if your health insurance has a high deductible that doesn’t automatically mean you qualify for an HSA.

So, only assume a health plan qualifies you for an HSA if it says so. And if you're unsure, contact the insurer and ask.

Downsides of Having an HSA

To know if paying more for an HSA-qualified health plan is worth it, you must fully understand the benefits and downsides.

The primary downside of an HSA is that spending it on non-qualified expenses, such as rent or a vacation, is against the rules. You’d be subject to paying income tax plus a hefty 20% penalty on those amounts. So, never put money into an HSA that you might need for everyday expenses.

Also, note that buying an HDHP isn’t for everyone. You must be sure you can afford the deductible. Additionally, If you have a chronic illness, take expensive prescription drugs, or have children, you could pay more for care than with other types of health plans that come with lower deductibles.

However, if you’re relatively healthy and don’t have many medical expenses, you’ll probably come out ahead by having an HDHP in combination with an HSA. Note that the purpose of having health insurance isn’t to cover every possible medical expense but to protect your finances against a devastating accident or expensive medical condition.

What Happens When You No Longer Qualify for an HSA?

A common question is what happens to an HSA if you become uninsured or switch to a non-qualified plan. The good news is that you can still spend it on qualified expenses tax-free. However, you won't be eligible to make new contributions if an HSA-qualified health plan does not cover you.

If you still have funds in an HSA after you turn 65, it morphs into something similar to a retirement account. You can use it for non-medical expenses without the steep 20% penalty; however, you must pay income tax on those withdrawals. That’s a great reason to max it out every year, even if you don’t expect many medical expenses.

How to Maximize Your HSA Benefits

The benefits you get from an HSA determine whether having an HDHP and paying a higher premium for one, in Katya's case, is worthwhile. Your funds can be spent on many expenses that aren't covered by your health plan, including your deductible, copays, coinsurance, dental bills, vision expenses, and hearing care, to name a few. I'll give you more examples of qualified expenses in a moment.

While there's no requirement for HSA participants to make contributions, annual caps do exist. For 2022, you can contribute up to $3,650 if you have insurance for yourself or up to $7,300 if you have a family plan. For 2023, those limits will increase to $3,850 and $7,750. Plus, if you're over age 55, you can contribute an additional $1,000.

Sometimes, employers offer HSA matching when you enroll in an HDHP at work. If so, company contributions get included in the annual limit. But note that no matter if you get HSA-qualified insurance on your own or through an employer, you can take it with you if you leave an employer, change your health plans, or retire.

Another way to get the most from an HSA is by using it for your family's medical expenses. You can spend it on qualified, out-of-pocket healthcare costs for you, a spouse, or your dependents.

A great HSA feature is that there's no spending deadline. If you don't have any medical expenses or don't want to use HSA funds to pay for them, your balance rolls over from year to year, even if you no longer have an HSA-eligible plan.

The bottom line is that the more you contribute, the more potential benefits you'll get from an HSA. But it won't improve your finances if you don't make any.

Which Healthcare Expenses are HSA-Qualified?

Once you've opened an HSA and have a balance, let's discuss how you can spend it. Allowable expenses include a wide range of healthcare costs you might incur until you meet your annual deductible or aren't covered by your health plan.

The IRS says for an expense to be HSA-qualified, it must pay for healthcare services, equipment, or medications that are unreimbursed. Also, you can’t itemize them as medical deductions on Schedule A when you paid for them using an HSA, which would be double dipping tax benefits.

There are hundreds of potential tax-free expenses; you can see the full list in IRS Publication 502, Medical and Dental Expenses. I’ll cover fifteen of them here.

1. Dental care

If you don’t have dental insurance or have out-of-pocket costs for oral care, including routine cleanings, fluoride treatments, X-rays, fillings, extractions, dentures, and braces, you can use HSA funds. However, cosmetic expenses, such as teeth whitening, are not qualified.

2. Vision care 

Any costs for surgery to correct your vision, such as LASIK or the removal of cataracts, can be paid with HSA funds.

3. Prescription glasses

You can use an HSA for getting an annual eye exam and new prescription glasses, sunglasses, and contact lenses.

4. Guide dog or other service animals

If your sight or hearing is impaired or you have physical disabilities, you can use HSA funds for a service animal. That includes the costs of buying, training, and maintaining a guide dog or other animal to assist you.

5. Chiropractic care

All chiropractic care is HSA-qualified, even if your insurance plan doesn't cover it. So, don't hesitate to seek it as an alternative for pain relief before you go for medication or surgery.

6. Acupuncture

Even if your health insurance doesn't cover acupuncture, you can use your HSA to pay for it tax-free.

7. Fertility enhancement

You can also use an HSA to pay for treatment to have children, such as in vitro fertilization. Once you’re a parent, you can spend it on breast pumps and supplies that assist lactation.

8. Birth control

You can use an HSA to pay for birth control, sterilization, or legal abortion.

9. Drug and alcohol addiction treatment

Any amount you pay for yourself or a family member on inpatient treatment at a drug rehabilitation center, including meals and lodging, is HSA-qualified. You can also pay for transportation to and from Alcoholics Anonymous meetings in your community.

10. Psychology or psychiatric care

Costs to support yourself or a family member through treating a mental condition or illness are HSA-qualified. You can use HSA funds to pay for a patient's treatment at a health institute if prescribed by a physician to alleviate a physical or mental disability or illness.

11. Home improvements

Any special equipment or improvements installed in a home to care for you or your family members can be paid for with an HSA if their purpose is medical care. These might include constructing entrance ramps, widening doorways, installing lifts, or lowering cabinets and sinks. Another expense that's HSA-qualified is removing lead-based paint in a home you own or rent.

12. Transportation and travel

Costs to get to and from any medical care, whether on a bus, taxi, train, plane, or ambulance, can be paid with HSA money. This rule includes regular visits to see an ill family member if visits get recommended as part of treatment. You can include lodging, but not meals, when you travel to another city for medical purposes.

If you use your vehicle to get to medical services, you can include out-of-pocket costs, including gas, oil, tolls, and parking fees, as HSA-qualified. However, you can't cover general vehicle maintenance or insurance costs.

13. Over-the-counter medicines

Starting in 2020, the IRS allows you to pay for over-the-counter pharmacy items, whether prescribed by a doctor or not. That opens up a wide variety of expenses, such as cold and flu medicine, pain relievers, sleep aids, eye drops, sunscreen, menstrual care products, and remedies for indigestion, acne, and motion sickness.

14. Certain health insurance

You typically can't use HSA funds to pay health insurance premiums–however, there are some exceptions. One is to pay COBRA coverage if offered by a previous employer. You can also use HSA funds to pay health premiums if you receive unemployment compensation under federal or state law. And you can pay for Medicare and other coverage if you're over 65.

15. Long-term care insurance

You can also pay long-term care (LTC) insurance premiums using HSA funds. Unlike regular health insurance, LTC pays a set amount of expenses for daily living, such as personal and custodial care in your home, a community organization, or other facilities.

Depending on your average tax rate, using an HSA to pay for these and many other allowable expenses means getting a 20% to 30% discount. Over your lifetime, that adds up to huge savings!

Should You Spend or Invest Your HSA Funds?

In addition to using HSA funds to buy qualified healthcare goods and services tax-free, there are other strategies you might consider. One is using it solely as an investment account instead of for medical expenses.

Since HSA rules don't require you to use or reimburse yourself for qualified medical expenses, you can opt not to make any account withdrawals. You can keep your balance invested if you have the cash to pay them. The idea is that the more money you contribute and keep in the account, the more time it has to grow tax-free.

Your HSA return depends on your contributions and investments, but it could be 7% or higher. If you're relatively young, maxing out an HSA and allowing it to grow for decades could be more lucrative than spending it tax-free on healthcare.

Another option is to allow your HSA to grow but use it to pay high or unexpected healthcare expenses as needed. However, if you change your mind and decide you want to reimburse yourself for all qualified expenditures, that's allowed and is known as "shoeboxing" your HSA.

Shoeboxing means keeping good records to verify all your qualified healthcare expenses and creating an IOU for yourself. You can redeem it any time you like by making withdrawals to reimburse yourself from your HSA. You typically receive a debit card with your account, but you can also initiate bank transfers or online bill payments to move money as needed.

Be sure you know how the reimbursed expenses were paid initially and that you didn't take them as itemized medical deductions on your taxes. As I previously mentioned, you can't do both. Also, note that you can't use HSA funds to pay expenses that occurred before you opened the account.

So, getting back to Katya's question about whether it's better to choose a more expensive HSA-qualified health plan, the answer is it depends. If you'd max out an HSA each year and invest your balance, it's worthwhile.

However, if you’re not already maxing out a retirement account, I’d encourage Katya to do that first. Using an IRA or a workplace retirement plan, such as a 401(k) or 403(b), should be your top investing priority.

While HSAs are loaded with tax benefits, they offer less flexibility than a retirement plan. Also, they're not known for providing best-in-class investments with low fees. They can also come with additional account and investing costs, which may erode their net investment returns.

But if you are maxing out a retirement account, you're also in an excellent position to max out an HSA. If all or most of your HSA balance gets invested in diversified funds, many experts would argue that it's better not to spend it and just let it grow.

Therefore, if you can afford not to tap your HSA, that likely gives you maximum tax savings, especially over a long period. However, if your HSA funds are not invested and are earning no or tiny amounts of interest, you'll probably come out ahead by spending them.

On the one hand, spending your HSA gives you guaranteed tax savings, which could be more than 30%, depending on your income and average tax rate. Finding an investment to beat that would be challenging.

On the other hand, letting your HSA stay invested at a good return for decades could be more valuable. As I mentioned, it depends on your return and how long the funds have to grow.

How do you open and fund an HSA?

If you qualify for an HSA, they're available at many banks, credit unions, brokerages, and specialty institutions. A few of my favorites are Starship, Lively, and HSA Bank. They're convenient and offer paper checks, debit cards, and online banking. Shop around to find an HSA that gives you diversified investment options, low fees, and a convenient online experience.

Are you like Katya and also have a money question or a topic suggestion? It’s easy to visit LauraDAdams.com and email me using my Contact Page–or leave a voice message at 302-364-0308. When you’re at LauraDAdams.com, you can also learn more about my work, books, and money classes.

If you haven't joined my free private Facebook Group, called Dominate Your Dollars, I'd love to have you! It's a fantastic group of people asking great questions, helping others, and reaching their financial goals. Just search for Dominate Your Dollars on Facebook.

That's all for now. I'll talk to you next week. Until then, here's to living a richer life.