Health Savings Accounts (HSAs) are on the rise. And yet, many people are confused about how HSAs work, and how to get the most out of them. HSAs are more than just a way to pay for medical expenses tax-free. Used correctly, they can be a valuable retirement savings tool.
Overview of HSAs
A Health Savings Account, or HSA, is a financial account established by an individual or family to pay for qualified medical expenses.
HSAs combine the benefits of both traditional and Roth 401(k)s and IRAs for medical expenses. Taxpayers receive a 100% income tax deduction on annual contributions, they may withdraw HSA funds tax-free to reimburse themselves for qualified medical expenses, and they may defer taking such reimbursements indefinitely without penalties.
5 Tips to Maximize Your HSA
1. Understand the benefits of HSAs
To maximize your HSA, it is first important to understand the benefits of an HSA. To summarize:
Contributions you make to the HSA, up to the annual limit, are tax deductible (see: 2014 HSA Contribution Limits). Likewise, any contributions made by your employer are excluded from your gross income ("pre-tax").
All contributions remain in your HSA indefinitely until you use them. There is no penalty if you don’t use the money, and it rolls over year to year.
Interest you earn on the account accumulates over the years tax-deferred, and if used to pay for qualified medical expenses is tax-free.
Withdrawals used to pay qualified medical expenses for you, your spouse, and your dependents are never taxed.
The account is portable and yours to keep. It stays with you if you change employers or leave the work force.
2. Contribute the maximum amount allowed
If you're using the HSA as a retirement savings vehicle and/or you anticipate having a lot of out-of-pocket medical expenses in the future, aim to contribute the maximum amount allowed each year.
The contribution maximums in 2014 are $3,300/year for an individual and $6,550/year for a family. In 2015 these increase to $3,350 and $6,650, respectively. Once you're enrolled in Medicare you no longer can contribute to an HSA, but people over 55 can make an additional catch-up contribution of $1,000/year.
If you can, have your contribution automatically deducted from your paycheck so you don’t even have to think about it.
3. Know what expenses are eligible
You may spend the HSA money tax-free on out-of-pocket medical expenses, such as your deductible, co-payments for medical care, prescription drugs, or bills not covered by insurance such as vision and dental care. The IRS determines the types of medical expenses you can use tax-free with HSA funds. They are listed in IRS Publication 502.
If you use HSA funds for non-medical expenses, you are required to pay taxes on the withdrawal, plus a 20% penalty before age 65.
4. Be an informed health care consumer
With a high deductible health plan and HSA, you (the health care consumer) have more control over the purse strings. As such, research and comparison shop. Most insurance companies now have tools such as online calculators to let you estimate the cost of big-ticket items such as an MRI or surgery. And, consider lower cost alternatives such as calling the 24-hour nurse line instead of going to the doctor's office for a minor ailment, and switch to lower-cost generic medication.
5. Keep your receipts
Lastly, you must keep receipts for everything you purchase using your HSA. If your HSA is ever audited you will need a record of your expenses. The easiest way to do this? Take a picture or scan your receipts and keep them electronically.
What are your tips for maximizing an HSA? Leave a comment below.
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