It's hardly a secret that healthcare in the United States is expensive -- very, very expensive. In 2020, the U.S. spent $4.1 trillion on healthcare, an eye-watering figure that evened out to over $12,500 per person. This makes America by far the most expensive country in the world for healthcare, beating the second-place contender, Switzerland, by more than $4,000 per capita.
To make healthcare more affordable, the federal government has put in place a few medical-related subsidies and tax breaks.
One of these initiatives is the Health Savings Account, or HSA. Introduced as part of the Medicare Prescription Drug Improvement and Modernization Act of 2003, the HSA is a highly tax-advantaged medical savings account that allows individuals and families with qualifying high-deductible health plans (HDHPs) to save in anticipation of certain health-related expenses that won't be covered by insurance.
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The lowdown on HSAs and HDHPs
Specifically, HDHPs -- which are offered by health insurance companies like Anthem (ELV -0.05%) and Humana (HUM -3.44%) -- must have annual deductibles of at least $1,400 per individual or $2,800 for families. Additionally, these plans' deductibles and co-insurance/co-pays combined can't exceed $7,000 annually per individual or $14,000 for families. These somewhat restrictive regulations mean that only taxpayers with specific kinds of health insurance arrangements may qualify for HSAs.
HSAs are also subject to their own set of contribution rules. In 2022, individuals are only allowed to contribute up to $3,650 a year, while families can sock away $7,300 a year.
On top of all that, HSA funds can only be spent on medically necessary health, vision, or dental expenses. Health-adjacent purchases like gym memberships, supplements, multivitamins, or toothpaste aren't HSA-eligible, while certain services like acupuncture or massages may require a Letter of Medical Necessity (LMN) from a healthcare provider before they can be expensed through an HSA.
Why bother with all these restrictions?
Your reward for navigating this labyrinth of rules and regulations? Massive tax savings. In fact, the HSA is so tax-advantaged that it's difficult to overstate how favorable they are to taxpayers.
To provide some context for how powerful the HSA can be, let's revisit two popular tax-advantaged retirement accounts, the traditional 401(k) and the Roth IRA.
As a refresher, the traditional 401(k) allows for tax-deferred contributions and tax-deferred growth, while withdrawals made in retirement are taxed as ordinary income.
On the other hand, Roth IRA contributions are made with after-tax money, but invested funds compound tax-free once inside the account and distributions are similarly tax-exempt.
Out of all three fronts -- contributions, growth, and withdrawals -- these retirement accounts are tax-advantaged in two areas: either in contributions and growth in the case of the traditional 401(k), or in growth and withdrawals when it comes to the Roth IRA.
Triple tax savings
By comparison, the HSA is tax-advantaged on all three fronts. Not only are contributions made with pre-tax dollars, but both growth within the account and withdrawals (spent on qualified medical expenses) are tax-free as well. In short, this means that each and every dollar associated with an HSA -- whether contributed, invested, or withdrawn -- is spared from taxation.
Suffice to say, the tax benefits of an HSA are enormous and can work powerfully in an individual or family's favor, especially in years when they're hit with unexpected out-of-pocket healthcare costs. While HSAs don't lower the cost of healthcare directly, they do provide people with a way to afford their medical care more comfortably without having to raid their retirement savings or resort to more desperate financial measures.
Is an HSA right for you?
Despite these tax advantages, it's important to remember that an HSA is first and foremost a savings account for health and medical-related expenses -- not a tax avoidance measure. In other words, whether you need an HSA (or not) should be primarily dependent on your current healthcare coverage arrangements in addition to the overall state of your health.
If you have comprehensive medical coverage through an employer-sponsored low-deductible plan, you may not need an HSA, nor will you be eligible for one. Likewise, if you're nearing retirement and think you'll be using a high volume of healthcare services, you may not be the best candidate for an HSA either.
However, if you're a young adult in excellent health and don't think you'll need much medical care at all (but nonetheless want a cushion in case a bad year comes up), you may be a good fit for the HSA. Younger, married couples and younger families with children without complex medical needs are similarly good candidates for HSAs. In summary, consider your health needs before you consider the tax savings -- that'll likely help you make the best decision for your situation.
