Your Complete 2019 Guide to the Health Savings Account

Here's everything you need to know about this triple-tax-advantaged investment account.

Matthew Frankel, CFP
Matthew Frankel, CFP
Mar 14, 2019 at 12:08PM
Financials

If you have a health insurance plan with an annual deductible of at least $1,350 for single coverage or $2,700 for a family, you may be eligible to contribute to a health savings account, or HSA. While millions of people meet these criteria, few take full advantage of the numerous benefits HSAs offer.

The biggest reason for this is that many of us don't realize these accounts exist, or don't fully understand just how wonderful they are. For example, did you know that you don't have to use all the money you contribute to your HSA every year? And you can choose to invest the money in your HSA, just like you would that in your 401(k).

With that in mind, here's a quick guide to the health savings account, along with 2019's eligibility requirements and annual contribution limits.

Pills on top of spread-out money

Image source: Getty Images.

What is a health savings account?

A health savings account, or HSA, is a tax-advantaged savings and investment account designed to help Americans with high-deductible health insurance plans save for their out-of-pocket medical expenses. Contributions to HSAs are tax-deductible, and withdrawals for qualified health-care expenses are tax-free as well.

As you'll see as we go through the details, an HSA is rather different from a flexible spending account, or FSA, even though they're both tax-advantaged vehicles for health-care savings. With an HSA, unlike an FSA, you can invest the money you contribute, and you can choose to carry over the funds from year to year.

In fact, you don't need to spend the money in your HSA in any specific time frame. That makes it an excellent way to save and invest for anticipated health-care expenses after retirement.

Do you qualify for an HSA?

As this guide will explain, there are unparalleled tax advantages that come with an HSA. However, there's one big catch -- not everyone is allowed to contribute to one.

The central requirement for HSA participation is having a qualifying high-deductible health plan. The exact IRS definition of this term changes annually, but for 2019, it refers to a health insurance plan with a deductible of at least $1,350 for self-only coverage or $2,700 for family coverage. So if you have individual health insurance through your employer and your plan has a $750 annual deductible, you are not eligible to participate in a health savings account.

To qualify, your health plan also needs to conform to an out-of-pocket maximum that is below a specified threshold. For 2019, the out-of-pocket maximum for an HSA-qualified health plan cannot be more than $6,750 for self-only coverage or $13,500 for family coverage.

For quick reference, here's a chart to determine whether your health plan qualifies you to participate in an HSA. To be perfectly clear, your plan must conform to both standards -- the minimum deductible and the maximum out-of-pocket expenses.

Qualification

Self-Only Health Coverage

Family Health Coverage

Annual Deductible (minimum)

$1,350

$2,700

Annual Out-of-Pocket Costs (maximum)

$6,750

$13,500

Data source: IRS.

It's important to mention that if you are covered by a high-deductible health plan as well as some other form of health coverage that doesn't have high deductibles (including Medicare), you can't use the high-deductible plan for the purposes of qualifying for an HSA.

Finally, HSA qualification is on a year-to-year basis. For example, if you have a high-deductible health plan in 2019 and make a contribution to an HSA, but you fail to qualify for some reason in 2020, you can't put any more money in the account. You can leave any existing balance in the plan if you choose, though.

How much can you contribute?

As long as you are eligible to participate in an HSA, the amount you're allowed to contribute depends on whether you have individual health coverage or a family health plan. The HSA contribution limits are set annually by the IRS; for 2019, they're $3,500 for self-only coverage and $7,000 for a family.

In addition to these limits, HSA participants who are 55 or older can contribute an additional $1,000 as a catch-up contribution. So if you're at least 55 years old and have self-only health coverage, you can contribute a total of $4,500 to your HSA in 2019. If you're 55 or older and are the primary insured on a qualifying family health plan, you can contribute as much as $8,000 to your account.

If your employer makes HSA contributions to your account on your behalf, it's important to realize that these are included toward your annual limit. For instance, if you have self-only coverage with a $3,500 contribution limit and your employer contributes $1,000 to your account, you are only allowed to contribute the remaining $2,500.

Your HSA contributions can be made until the April tax deadline in any given year. This is generally April 15, as it is in 2019, but it can differ slightly because of weekends or holidays.

It's also worth mentioning that there have been efforts to dramatically increase these contribution limits, including a bill that passed the House of Representatives in 2018 that would have roughly doubled them. While the ability to save more for health care does garner some bipartisan support, no new laws governing HSA contribution limits have passed as of this writing.

One big difference from the FSA

Health savings accounts are often confused with flexible spending accounts, or FSAs, but there are a few major differences. For one thing, there is no deductible or out-of-pocket maximum to save in an FSA.

In addition, one big difference is that money in an FSA generally has to be used during the same year. A small amount can be carried forward, but you can't simply max out your contributions to your FSA year after year and accumulate a large balance without spending any of the money.

However, you're allowed to do exactly that with an HSA. There's no rule that says you have to use the money you contribute to your HSA every year. In fact, one characteristic of a HSA encourages you to contribute more each year than you think you'll need immediately, as we'll see in the next section.

Investing in an HSA

Unlike an FSA, the money you contribute to an HSA isn't just sitting in cash like it would in a checking account. One of the most interesting aspects of a HSA is that money in the account can be invested.

HSAs typically offer a selection of options for investment. You can choose to keep the money in cash or equivalents, but there's generally a 401(k)-like selection of investment funds you can put it into, as well.

Obviously, if you contribute money to a HSA and then use it shortly after to cover health-care costs, the fact that this money could have been invested isn't likely to do you much good. On the other hand, if you use an HSA to build a health savings bankroll over the years, the investment feature can be one of the best things about the account -- as you'll see, HSAs offer a set of tax advantages unmatched by other tax-advantaged savings vehicles.

The ability to invest funds is perhaps the least understood of the HSA's benefits. According to recent reports, only about 6% of Americans who have HSAs invest their account funds -- and investment may be the most compelling reason to use a HSA in the first place.

The 3 tax benefits of HSAs

If you take advantage of your HSA, as well as the ability to invest your money within it, there's a unique triple tax advantage to HSA investing that simply doesn't exist in other tax-deferred investment vehicles. Consider these three points:

  1. If you're eligible to contribute to a HSA, you contributions are tax-deductible up to your annual maximum. For example, if you're under 55 and have family coverage, contributing the maximum to your HSA for 2019 will lower your taxable income by $7,000.
  2. While your money is invested in a HSA, it grows on tax-deferred. This is the same tax deferral that occurs in an IRA, 401(k), or other retirement vehicle, meaning that you don't have to pay annual taxes on capital gains, interest income, or dividends that occur within the account.
  3. Withdrawals from your account that are used to pay for qualified health-care expenses are 100% tax-free. This essentially combines the tax-free withdrawals of a Roth IRA with the tax-deductible contributions of a traditional IRA or 401(k).

Here's a simplified example that illustrates what a valuable benefit this is. Let's say you're 35 and have a qualifying family health plan. If you contribute $7,000 per year to a HSA for the next 20 years, you'll have excluded a total $140,000 from your taxable income. At the end of the 20-year period, your account could be worth about $287,000, assuming 7% annualized investment returns -- and you'd be free to withdraw this money tax-free to cover any out-of-pocket health-care costs. That's a $147,000 profit on your investment that won't cost you a dime in taxes if you use it for qualified reasons. Or you can simply let it continue to grow to give you a huge nest egg for health care in retirement.

What can you use HSA funds for?

One of the biggest questions on your mind at this point might be, "What qualifies as a health-care expense for HSA purposes?" In other words, what are the allowable reasons to take tax-free distributions from your HSA?

The IRS provides a thorough list of expenses that qualify for HSA tax-free distributions in Publication 502, but here's a quick list of some of the most common:

  • Prescription medications
  • Nursing services
  • Long-term care services
  • Dental care
  • Eye care, including eye exams, glasses, and contact lenses
  • Psychiatric care
  • Surgical expenses
  • Fertility treatments
  • Chiropractic care
  • Medical equipment
  • Hearing aids

Once you turn 65, the rules change

Generally speaking, HSA withdrawals do need to be used for qualified medical expenses as defined by the IRS. But this rule only applies to people under 65 years old.

Once you reach age 65, you can withdraw money from your HSA for any reason. If you withdraw the money without using it for qualified medical expenses, it will be treated as taxable income, but no penalty will apply. In other words, it's treated the same as if you withdrew tax-deferred money from a traditional IRA or 401(k) after reaching full retirement age (although it's worth mentioning that the penalty-free withdrawal age for most other retirement accounts is 59 and 1/2 years old). This is one of a few reasons why HSAs also make good retirement savings vehicles.

What if you withdraw money early for non-medical expenses?

One drawback to saving and investing in a HSA (there's no such thing as a perfect investment account) is the penalty for non-qualified withdrawals.

If you're under 65 and withdraw money from your HSA without a qualifying medical expense to pay for, you'll face a 20% early withdrawal penalty from the IRS, in addition to any income taxes you'll have to pay on the money.

This is double the 10% early withdrawal penalty that is associated with IRAs, 401(k)s, and most other qualified retirement plans. In other words, if you withdraw $10,000 from your HSA simply because you need the money, you're looking at a $2,000 penalty plus any taxes you'll have to pay.

A great retirement option

Because of its tax-deferred investment nature combined with the ability to take tax-free distributions to cover medical expenses, a HSA can be a wonderful way to plan for, and reduce, your health-care expenses in retirement.

Fidelity's 2018 Retiree Health Care Cost Estimate determined that the average couple who retires at age 65 in 2018 will spend a total of about $280,000 (in today's dollars) on out-of-pocket health-care expenses throughout their retirement. This is why you should seriously consider taking advantage of a HSA if you qualify to do so.

Here's the point: If you are in the 22% tax bracket after you retire, withdrawing enough from tax-deferred accounts like traditional IRAs and 401(k)s to be left with $280,000 after taxes means that you'll actually need to take out close to $360,000 -- more, if you live in a state with income tax. But if you need to cover $280,000 in health-care expenses and plan to withdraw it from a tax-free account like an HSA, $280,000 is all you'll need to withdraw.

In addition, there are a few other qualities of a HSA that make it a great retirement-savings method. For one thing, the $7,000 contribution limit for family coverage is $1,000 more than the 2019 IRA contribution limit. And there are no maximum income thresholds for participation as there are with IRAs; no matter how much you earn, you can save in an HSA and take advantage of its tax benefits as long as you have a qualifying health plan.

And finally, once you reach retirement age, there's no required minimum distribution (RMD) to worry about after age 70 1/2, like there is with other tax-deferred retirement accounts. If you want to leave your account balance alone to grow and compound in anticipation of future health-care expenses (such as long-term care), you're free to do just that.

How to open and fund an HSA

If you have a qualifying high-deductible health plan, your employer may offer an HSA. If this is the case, it's usually an attractive option, especially if your employer makes some degree of HSA contributions on your behalf.

Alternatively, there are several reputable financial institutions that offer HSAs. For example, Lively offers HSAs with a FDIC-insured savings account option and the ability to invest your account funds through TD Ameritrade's platform, which lets you choose virtually any stocks, bonds, ETFs, or mutual funds you want. HSABank is another one that offers investment options through TD Ameritrade and may be worth a look.

Generally speaking, you need to choose one HSA account. In other words, you probably can't use your employer's HSA and another one at the same time. The choice comes down to the best option for your goals. If your employer is willing to contribute money on your behalf for a specific HSA, the choice is generally easy. If not, it's a good idea to compare the features of the plan your employer offers directly (if any) with a few other options. For example, if you'd like to buy individual stocks in your HSA, you'll need to be sure to find an institution that allows you to do that.

The bottom line on HSAs

The bottom line is that a HSA is a wonderful way to set aside money on a tax-deferred basis for medical expenses -- but with the ability to invest and carry over a balance from year to year, it's so much more than that. If used as a long-term investment vehicle, your HSA could literally save you tens of thousands of dollars on your health-care costs after retirement, while saving you thousands on your tax bill in the meantime.