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Written by Beau Jordan on April 25, 2022
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HSA For Beginners 2022: A Complete Guide To Health Savings Accounts!

If you have been in the market for a new healthcare plan you probably have heard about Health Savings Accounts (HSAs). What you may not know is that HSAs have benefits that extend far beyond just healthcare

If you ask your parents about Health Savings Accounts though, they may not be as familiar with them as other healthcare plans. This is because HSAs weren’t created until 2003 when George W. Bush signed the Medicare Prescription Drug Improvement and Modernization Act of 2003.

The U.S. Department of Treasury states that HSAs were created to provide individuals with high-deductible health plans tax-preferred treatment for money saved for medical expenses. 

Many HSA plan owners also use the account tax benefits to save for retirement. The purpose of this article is to highlight the many use cases and benefits of creating an HSA. Some of those key points include HSA plan qualifications, tax benefits, and retirement investing opportunities.

What is an HSA?

HSA stands for Health Savings Account. An HSA is a special savings account to be used specifically for healthcare expenses. In order to create an HSA though, you must be enrolled in a high deductible healthcare plan (HDHP). 

In other words, if you are not enrolled in a high deductible healthcare plan, you will not be eligible to create an HSA. Additionally, enrollment in additional health coverage outside of your high deductible healthcare plan may deem you ineligible to create an HSA. 

Let’s dive into some healthcare terminology to better describe the many aspects of an HSA. 

Healthcare Terms and Basics

A healthcare premium is the monthly or annual payment that you pay to the insurance company to be insured. Regardless of your healthcare plan usage, you will always be responsible to pay your healthcare premiums. 

A healthcare deductible is the covered expenses that you must pay before your insurance coverage kicks in. HSA plans are characterized by having high deductible plans. This means that the deductible may be $3,000 or more before insurance kicks in.

High deductible healthcare plans are characterized by having very low premiums with very high deductibles. There is a relationship between the healthcare premiums and plan deductibles. This inverse relationship results in lower premiums when the deductible is high and higher premiums when the deductible is low. 

Unlike other healthcare plans, high deductible healthcare plans do not typically have copayments. A copayment is the fixed amount that you would pay for going to a certain healthcare provider. An example is a flat rate $50 for a specialty doctor. 

With a high deductible plan, expect your expenses for seeing a specialty doctor to be considerably higher if you are going before you have hit your deductible. This is because until you hit your deductible, you are responsible to pay for medical expenses out of pocket

You will still receive discounted rates since you are insured but that discount is not as good as the discount for copayments. 

Once your coinsurance hits though, your healthcare expenses are expected to drop significantly. Coinsurance is the amount that you are still responsible for after a deductible is met. A common ratio is that coinsurance is 20% while the insurance covers the other 80%. However, this ratio differs depending on the price of the plan. 

Using the same deductible example above of $3,000 and a coinsurance of 20%, let's pretend you are using your insurance for the first time this year. Your total medical bill ends up being $4,000 billed to you. 

The first $3,000 of that bill you will pay 100%. That is because you have to meet your deductible before your insurance starts sharing the bill. The next $1,000 you will only be responsible for $200 because of your coinsurance responsibility (20%). The other $800 will be paid by your insurance company (80%). 

The last term that is important to understand is the out of pocket max. This is the upper limit of your financial exposure to healthcare expenses in a year. Sometimes the deductible and out of pocket max can be the same in a high deductible healthcare plan.

How Does an HSA Work?

Taking all of that terminology, let’s discuss how an HSA actually works then and how it coincides with your high deductible healthcare plan. 

Typically, health care plans provide “use it or lose it” funds that may result in you over paying your fair share of health expenses. These “use it or lose it” benefits come in all different shapes and sizes. Some examples are low deductibles and max out of pockets but high premiums. If you never use your health benefits, you lose them and continue to pay the premium month after month. 

Luckily, HSAs are a great solution to that “use it or lose it” problem. You could even consider HSAs as the “use it and save it” or “use it and invest it” healthcare solution. 

Since high deductible healthcare plans (that are required to have HSAs) have low premiums, the money saved can be used for future health care expenses or even for retirement. HSAs can be used throughout your entire life (more details to come).

HSA Tax Advantages

One of the primary reasons for switching to an HSA is for the tax advantages. HSAs are the triple threat when it comes to tax savings. That triple threat is evident in the fact that HSA contributions, earnings, and distributions are all tax free. 

Contributions

Whenever you contribute to your HSA, the contributions are 100% tax deductible. This tax deduction applies whether the contributions were from you, your employer, or your friends. 

Tax deductions lower your taxable income. In other words, it means that the income contributed to your HSA is tax free!

HSA Contributions

This also means if you contributed through your payroll, that income is not subject to Social Security and Medicare taxes. The social security tax in the United States is 6.2% and Medicare tax is 1.45%. Those tax breaks add up to huge savings! 

Your employer also benefits from HSA contributions. They receive tax savings on FUTA and SUTA taxes with HSA contributions. Needless to say, contributing to an HSA is a win-win for employees and employers. 

Earnings

Another great tax benefit, and perhaps the greatest tax benefit, is the HSA earnings tax break. HSA earnings can come from interest made in the account as well as earnings from investments. 

Once you have a certain amount in your HSA, you can begin investing your HSA funds into the equity markets (i.e. stocks and bonds). All of the gains that you make on those investments are 100% tax free! Additionally, any interest made in your HSA checking account is also tax free.

This earnings tax break is a very similar concept that you can find with Roth IRAs. However, the contributions to an HSA are tax free where the contributions to Roth IRAs are taxed. 

Distributions

The last piece of the HSAs triple threat tax savings comes from HSA distributions. When you use funds from your HSA for qualifying expenses, they are also tax free. Before you are 65 years old, a qualifying expense can be defined as qualified medical expenses (more to come later). 

If you use your HSA for non qualified expenses before you are 65, there will be a 20% penalty on top of an additional tax penalty.  

However, once you are 65 years old, you are free to use your HSA for any and every expense. At that point, all distributions (medical or not) are tax free!

HSA Contribution Limits

With great tax benefits come great responsibilities. The United States government heavily regulates HSAs because they offer such fantastic tax breaks. One of the methods the government uses to regulate HSAs is to have annual contribution limits

HSA contribution limits are the maximum amounts that you are allowed to contribute to your HSA in a given year. Typically, the contribution limits rise slightly year over year.

There are two different buckets for contribution limits. The first bucket is for self-only plans and the second bucket is for family plans. Self-only plans are for those that are insuring only themselves rather than an entire family. 

In 2022 the HSA contribution limits for self-only plans are up $50 from the year prior and sit at $3,650 a year. The family contribution limits are up $100 from the year prior and currently are at $7,300 a year.

Any amount contributed over the contribution limit is not tax deductible and results in a 6% excise tax. There are no benefits to contributing more than the contribution limit. 

In the event that you did not reach your annual contribution limit, you usually have a bit of time the following year to max out. The last day to make contributions to your HSA is typically the tax-filing deadline the following year. 

This means that up until April 15, 2022 you still have time to contribute to your 2021 HSA contributions. Of course, you must have had qualifying coverage during that period for that to be applicable. 

HSA Ownership

If at any point in your life you have an HSA, that HSA is yours for the rest of your life. Remember, these are not “use it or lose it” plans. You can contribute to your HSA in 2022 and then use those funds in 2050 (if they are still available)!

Let’s take a couple of examples to prove this point.

Let’s say you have a high deductible healthcare plan and create an HSA in 2022. Then in 2023 you decide to pick a non-qualifying healthcare plan and thus can no longer contribute to your HSA. While you cannot continue to contribute to your HSA in 2023 with your non-qualifying plan, you can use your funds from your HSA at any time. 

Another great example would be that in 2021 you have a high deductible healthcare plan through your job and create an HSA in 2021. Then in 2022 you switch (or lose) your job and start working with a new company. The HSA is yours and rolls over with you wherever you go!

How Does an HSA Compare to an IRA or 401(k)?

IRAs, 401(k)s, and HSAs have similarities but are all unique in their own ways. As a quick recap, an IRA is a retirement investment fund that allows you to save for retirement with either tax-free growth or on a tax deferred basis. 

A 401(k) is very similar but is a company-sponsored retirement account that employees can contribute to while companies may offer matched contributions. 

Both IRAs and 401(k)s have you choose either to have tax-free growth in the retirement fund or tax deferred contributions. A Traditional IRA or 401(k) allows you to tax defer your contributions. This means that the contribution amount is tax free income. 

A Roth IRA or 401(k) is the option where your investments will experience tax-free growth. This means that you will not have capital gains taxes on those investments. On the other hand, all of your contributions to Roth accounts do not have tax benefits.

An HSA is the best of all worlds when it comes to IRA and 401(k) tax advantages. In fact, an HSA seems to be the perfect blend of the two with even more benefits. 

Like a Traditional IRA and 401(k), HSA contributions are tax free (count as a deduction come tax season). Like a Roth IRA and 401(k), HSA investment growth is tax free. You don’t need to choose one tax benefit over the other as they are both offered. 

Additionally, an HSA can be contributed to using your own income, your employer's contribution benefits, or even a family member's contributions. It truly is the best of all worlds when it comes to tax advantages. 

Additional HSA Advantages

There are a few additional HSA advantages that are worth bringing back up! The first is that you can use your HSA on your spouse and all qualified dependents.

Let’s pretend your spouse is under the age of 26 and thus is still on his/her parents insurance policy. You however have an HSA plan. You are allowed to use your HSA to pay for any of your spouses and children’s medical expenses. 

Another advantage is that you can contribute both earned and unearned income. So whether you want to contribute straight from your employer or wait until the money hits your bank account, both work. 

Who Can Establish and Contribute to an HSA?

As long as you are covered on a qualified high deductible healthcare plan, you are allowed to create and contribute to an HSA. You cannot establish an HSA if you are enrolled in a disqualifying coverage, have medicare, or are claimed as a dependent on another’s tax form. 

As long as you meet the above requirements you are good to create the account and are allowed to start contributing. Once the account is created though, regardless of your current insurance coverage, the HSA is and will always be yours. 

However, as soon as you are enrolled in a disqualifying health plan, you lose the right to contribute to your HSA. You still have the right to use the HSA funds but you are no longer allowed to contribute year after year. If you ever go back to a high deductible healthcare plan, you will be allowed to contribute again for that calendar year. 

Contributing to an HSA

As was described above, the HSA will always be yours the minute after you create the account. Use this to your advantage and max out the account!

HSA contributions are unique in that they apply to specific tax years. As a result, you typically have the opportunity to contribute to the previous year's contribution limit as long as you are still within the tax filing deadline. 

To recap, let’s take the 2021 contribution year as an example. As long as you had an HSA in 2021 you were able to contribute throughout the entire year. At the end of 2021 pretend you still had $1,000 to contribute before reaching the contribution limit. 

Luckily, you have until the tax deadline in 2022 to continue to contribute to the 2021 year. That means you have until April 18, 2022 to make all your contributions to the 2021 HSA year. 

Contribution limits are changing every year though so make sure that you keep in touch with what the contribution limits are so you do not over contribute. 

If you are younger than 55 years old, your contribution limits for the year 2022 are $3,650 for self-only coverage and $7,300 for family coverage.

Once you are 55 years of age or older though, the contribution limits change. This is because at the age of 55 you are allowed to start making catch up contributions. This means that those over 55 have an increase of $1,000 to add to their HSA each year. 

A married couple with two HSAs are allowed to contribute $1,000 each for the catch up contributions (for a total of $2,000).

While catch up contributions are great, take advantage of time and contribute as much as you can while you are young. The longer your investment sits working in the equity markets, the more impact compound interest has on your investment. 

Penalties of Over Contributing

It is important that you keep detailed notes of how much you have contributed each year. If you over contribute there is a heavy penalty that you can easily avoid by tracking your contributions. 

If you over contribute, you will have to pay income tax for any amount that you contribute over the contribution limits. The government also punishes you with an additional 6% tax called an excise tax penalty. This is a penalty that comes in addition to your normal income tax. 

Unfortunately, even if an employer contribution caused the excess contribution, you are responsible to pay the taxes and penalties. Again, this can easily be avoided by confirming that you do not contribute over each year’s HSA contribution limit. 

Spending HSA Funds

Another important aspect of an HSA is how you decide to use the contributions. The government is pretty hands on when it comes to what you can and cannot use your HSA funds on. As an overview, you are allowed to use your HSA funds on qualified medical expenses

HSA Medical Expenses

There is a giant list of what is and is not allowed to apply HSA funds is found on the IRS website. The IRS states that Publication 502 lists expenses that “generally” qualify for medical deductions. There are also a few guiding principles that may help you understand what you are allowed to use your HSA funds on. 

You are allowed to use HSA funds on the cost and treatments of diseases, services rendered by medical professionals, and prescribed medical goods and services used to alleviate or prevent illness. 

This list is not comprehensive and owners of HSAs should confirm that their use cases are qualified expenses before using HSA funds. 

Transferring HSA Fund to Pay for Expenses

There are a few options that you have to pay for your qualified medical expenses using your HSA. Each HSA administrator will have different processes so it is important that you confirm your chosen process with your administrator. 

Some administrators will offer debit cards while others may offer checking account checks to pay for your qualified expenses directly from your HSA. However, all administrators will allow you to use a personal account or credit card and then reimburse yourself

Timing of Expenses

As was discussed earlier in the article, when you begin coverage with your high deductible healthcare plan is very important. If qualified medical expenses incurred before you had HSA coverage, you cannot use your HSA funds on that expense. 

However, as long as your qualified expenses are incurred after coverage began, you are good to use your HSA funds. In fact, as long as your qualified medical expenses are incurred during a covered period, there is no limit on when you can use the funds. 

To illustrate the above principle, pretend that you began high deductible health plan coverage in January of 2021. You had $1,000 of qualified healthcare expenses but instead of using your HSA immediately you decided to let your funds continue to invest and paid your medical bill out of pocket

Then, 10 years down the line you decide that you want to reimburse yourself out of your HSA for those medical expenses incurred in 2021. As long as you have a record of your qualified medical expense in 2021 for $1,000 you are allowed to reimburse yourself.

This is beautiful because you have allowed your investment to grow tax free and still are able to repay yourself. At that point 10 years down the line too, you don’t need to use those funds on medical expenses again. This is a reimbursement of a qualified medical expense so now that you reimbursed yourself you are free to use those funds however. 

Saving and Investing HSA Funds

When you have funds in your HSA that you are not using for qualified medical expenses, you have the opportunity to save and/or invest your funds. 

Once you contribute to your HSA the money will immediately sit in an HSA checking account. This account works like any other checking account where you earn interest on the money sitting in the account. Depending on the bank and year, the interest rate offered will vary. 

Typically, the funds sitting in your HSA checking account are FDIC insured which protects your money in the case of bank failure. However, if you want a higher rate there are options to get a higher interest on your account but those may cause your funds to not be FDIC insured. 

Once you have a minimum threshold of funds in the account, you will gain the opportunity to invest any additional funds. Most HSAs have a required minimum of $1,000 or $2,000 to be in the account before you begin investing. 

Every dollar over the minimum threshold you then can invest into the exact same funds available for IRA users. These investment channels include bank accounts, annuities, certificates of deposits (CDs), stocks, mutual funds, and bonds. 

Since the primary use of your HSA is to pay for qualified medical expenses, you can freely move your funds from your investments to your checking account without penalties or negative impact to your annual contribution maximum. This is because the IRS views such transactions as a dispersal and not an HSA contribution.

HSA Record Keeping Advice

One of the final topics to cover with HSAs is the importance of detailed record keeping. Since there are specifics around what is and is not HSA eligible, the government requires strict record keeping of all HSA funds. 

In the event that you get audited by the government for use of HSA funds (which you report on contributions and distributions each tax year), you will need to provide proof of the qualified use of funds. 

In the event that you do not have correct documentation you may face a 20% penalty plus income taxes for the unauthorized distributions. Even if you used the funds on qualified expenses but fail to provide correct documentation, you may be faced with those heavy penalties. 

Some of the documentation that you are required to keep track of are receipts, coverage documentation, proof of payment, and EOBs. Check with your HSA provider to confirm you are keeping correct documentation though. 

Additionally, your HSA provider may have resources to help you better track all of your qualified expenses. For example, many providers provide applications where you can upload receipts and detailed information about each expense. Whatever your method though, make it detailed. It is better to be safe than to be sorry!

Is an HSA Right For You?

As described throughout this article, HSAs are a fantastic tool to create opportunity and tax-free savings for retirement. However, an HSA may not be right for you and your current life situation. 

The first thing you need to determine is whether or not a high deductible healthcare plan is right for you and your family. Typically high deductible healthcare plans work for people who are not expecting to have many health expenses throughout the year. 

If you know that you have significant medical expenses throughout the year it may be better to go with a lower deductible plan so that you are paying less out of pocket for all of your medical needs. In the end, if a high deductible healthcare plan doesn’t work for you or your family, you may end up saving more money going with a different medical plan than with an HSA. 

HSA for Beginners 2022: Final Thoughts

To recap, there are a lot of opportunities that come from having a high deductible healthcare plan and HSA. High deductible healthcare plans have lower premiums that open the door to healthcare savings. You have the opportunity to take those savings and use them to invest in your HSA. 

An HSA is tax free on contributions, earnings, and distributions. To put this into a real life scenario, let’s say that you contribute $100 into your HSA. That contribution reduces your annual tax liability by $100 (making it a tax free contribution). Then, you decide to invest that $100 from your HSA and it grows to $120.

When you have your next qualified medical expense, like a doctor's appointment, you decide to sell your $120 investment and then it lands back in your HSA. That $20 capital gain is also tax free. 

Lastly, when you distribute the funds to pay for your qualified medical expenses you do not add additional tax liabilities. 

One other key benefit from your HSA is that once you reach the age of 65 you can use your HSA funds on whatever you want. At that point, you will not be limited to qualified medical expenses. You truly have the ability to use your HSA funds on whatever you want in your retirement. 

Even with all of these advantages, there is still a chance that an HSA is not right for you. Some high deductible healthcare plans don’t offer the right healthcare coverage for you. In those cases, creating an HSA may not carry the same advantages as they would for another. Whatever your situation, weigh the pros and cons to see if creating an HSA is right for you!

To learn more about what the IRS has posted about HSAs visit the official website and check out Publication 969.

Article written by Beau Jordan

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