Health insurance is expensive. People can argue all day about why it’s expensive and how to fix it, but at the end of the day it’s still expensive. That’s why it surprises me every tax season how little people utilize Health Savings Accounts (HSAs).
When people hear about HSAs, they sometimes confuse them with their cousin plans, Flexible Spending Accounts (FSAs). FSAs were introduced before HSAs, but are not wildly popular due to the fact that you had to (somehow) predict your total medical expenses at the beginning of the year, and if you guessed too high the money just disappeared at the end of the year.
HSAs are much different - and better - vehicles for saving for health expenses. An HSA is one of the few accounts that you can contribute to tax free, withdrawal from tax free (assuming the withdrawal is for health expenses), and any interest or other earnings on the account are tax free. Plus, with HSAs, the money is yours until you spend it - no disappearing money.
Even better, if you use your employer’s HSA and change jobs you can take the account with you when you leave, just like your 401(k). Additionally, if your employer does not offer a plan, there are multiple companies that you can open an HSA with independently. If you are self-employed, you can qualify for an HSA (unlike an FSA).
Let’s run a few scenarios:
Say you have a $500 medical expense, and you are in the 25% tax bracket. By putting $500 into an HSA and then using that money to pay for your medical expense you just saved yourself $125.
This may seem like a lot - or not - depending on what your finances look like. But let’s take a look at another scenario. Say you’re planning on having a child and your maximum out of pocket for your insurance is $7,000. Putting $7,000 into an HSA to cover prenatal checks, delivery, checkups, and whatever else may arise would save you $1,750. That would buy a lot of diapers.
There are some downsides to an HSA plan, however. Namely, you must have a high deductible health plan in order to qualify. So if you don’t have a health insurance policy, or you are one of the lucky few that don’t have a high deductible policy, you won’t qualify for an HSA. Additionally, you will have to keep records of your health costs so you can prove any withdrawals were for qualified health expenses if asked. Lastly, if you pull money out of the HSA before you are 65 years old, for non-health expense reasons, there is a 20% penalty.
Personally, I like to make sure I have my insurance’s maximum out of pocket expense in my HSA at all times. If anything major were to happen, the last thing I want to worry about is how to pay my deductible.