Health savings accounts (HSAs) are investment accounts that allow you to set aside pre-tax dollars for "qualified medical expenses" to pay for outlays not covered by your health insurance plan. By setting aside money pre-tax, your contributions don't count toward your adjusted gross income at the end of the year. But in order to take advantage of HSAs, you'll need to understand how they work and the rules that apply.
1. To open an HSA, you need to be covered by a high deductible health plan (HDHP). An HSA is a type of tax-advantaged medical savings account, with features that could help you save for medical expenses and give you the option to invest those funds. However, in order to qualify for an HSA, you must participate in a HDHP. In these accounts, you pay more of your medical expenses out of pocket, with insurance coverage applying only after you reach a certain deductible that's set by the IRS annually. You can use the funds that you put aside in your HSA to pay for expenses not covered by your health insurance.
2. If your employer doesn't offer an HSA, you might be able to open one on your own. While many employers offer HSAs, you might still be able to open one even if your employer doesn't, or if you're self-employed. If you choose to set up an HSA on your own, the same tax features apply. There are eligibility limitations, so make sure to check with a tax professional.
3. HSAs are investment accounts. In many ways, HSAs are similar to 401(k)s. If you set up an HSA at work, your money is deducted from your paycheck pre-tax, and you can generally choose among investments such as stocks and mutual funds in which to invest the funds you contribute. Your employer might make contributions into your health savings account, as well. If you set up an HSA on your own, your choices can vary by financial institution. Either way, HSAs usually provide the option to keep some or all of your contributions in cash.
4. Withdrawals from an HSA are never taxed as long as the money is used for qualified medical expenses. The money in an HSA belongs to you, whether you use it for future medical expenses or not. However, if you don't put withdrawals toward medical expenses, you'll be subject to income taxes on that money. In addition, you'll be subject to a 20 percent penalty on HSA distributions used for non-medical expenses unless you've reached the age of 65 or become disabled.
5. Funds in your HSA don't need to be withdrawn at the end of a plan year. Your dollars can be rolled over year after year--meaning there's no "use it or lose it" constraint. By letting these funds accumulate, they can be saved for large medical expenses, and there are no required minimum distributions. In addition, an HSA is "portable," meaning you can take the account with you if you switch jobs or leave the workforce.
6. They're not the same as FSAs. Flexible spending accounts (FSAs) are employer-sponsored accounts that let you set aside pre-tax dollars for eligible healthcare costs. However, while you control the funds in an HSA, the money in your FSA is held by your employer, and any funds not used by the end of the end of the plan year are generally forfeited.
Before establishing an HSA or making contributions, you might want to seek advice from a tax professional, an investment professional or your human resources department.
Learn more about investing.
