Health Savings Accounts: Advantages and Disadvantages

A Health Savings Account (HSA) is like a personal savings account, but it can only be used for qualified healthcare expenses. To be eligible, you must be enrolled in a High-Deductible Health Plan (HDHP). Health Savings Accounts also have some important tax advantages.

Many Expenses Qualify. Eligible expenses include a wide range of medical, dental and mental health services. They are explained in detail in IRS Publication 502, Medical and Dental Expenses.

Others Can Contribute. Contributions can come from you, your employer, a relative or anyone else who wants to add to your HSA. The Internal Revenue Service does, however, set limits. For 2019, for example, the limit is $3,500 for individuals and $7,000 for families, plus an additional $1,000 "catch-up" contribution for anyone age 55 or older by the end of the tax year.

Pre-Tax Contributions. Contributions are typically made with pre-tax dollars, through payroll deductions at your employer. As a result, they are not included in your gross income and are not subject to federal income taxes. In most states, contributions are not subject to state income taxes.

Tax-Deductible After-Tax Contributions. If you make contributions with after-tax dollars, you can deduct them from your gross income on your tax return, reducing your tax bill for the year.

Tax-Free Withdrawals. Withdrawals from your HSA are not subject to federal (or in most cases, state) taxes if you use them for qualified medical expenses.

Tax-Free Earnings. Any interest or other earnings on the money in the account is tax free.

Annual Rollover. If you have money left in your HSA at the end of the year, it rolls over to the next year.

Portability. The money in your HSA remains available for future qualified medical expenses even if you change health insurance plans, go to work for a different employer, or retire.

Convenience. Most HSAs issue a debit card, so you can pay for prescription medications and other eligible expenses right away. If you wait for a bill to come in the mail, you can call the billing center and make a payment over the phone using your debit card. 

The High-Deductible Requirement. A High-Deductible Health Plan, which you are required to have in order to qualify for an HSA, can put a greater financial burden on the patient than other types of health insurance. Even though you will pay less in premiums each month, it could be difficult—even with money in an HSA—to come up with the cash to meet the deductible for a costly medical procedure.

Pressure to save. Some people are reluctant to seek healthcare when they need it because they don't want to spend the money in their HSA account.

Taxes and penalties. If you withdraw funds for non-qualified expenses before you turn 65, you'll owe taxes on the money plus a 20% penalty. After age 65, you'll owe taxes but not the penalty.

Recordkeeping. You must keep receipts to prove that your withdrawals were used for qualified health expenses.

Fees. Some HSAs charge a monthly maintenance fee or a per-transaction fee, which varies by institution. While typically not very high, the fees do cut into your bottom line. Sometimes these fees are waived if you maintain a certain minimum balance.

• A Health Savings Account (HSA) can help patients with high-deductible health insurance plans cover their out-of-pocket costs.
• Contributions to HSAs generally aren't subject to federal income tax, and the earnings in the account grow tax-free.
• Unspent money in an HSA rolls over at the end of the year so it's available for future health expenses.
• High-deductible health plans, which are a requirement for HSAs, aren't always the best option for patients, especially those who expect to have significant healthcare expenses in the future. Those patients may be better off with an insurance plan that charges higher premiums upfront but covers a greater percentage of their costs.

[Important: The money in your Health Savings Account can be rolled over year after year so it's available for future expenses.]