At the start of the year, I opened my first Health Savings Account (HSA). As a consequence of changing from fulltime to part-time work, I lost my company-sponsored health insurance plan. After a lot of research, I decided on a high deductible health insurance plan (HDHP) eligible for an HSA. I understood the basics of an HSA but still lacked the details. This article reveals my top 10 HSA questions and answers I compiled.
I had little knowledge of what an HSA is and what the benefits are. I knew it was a savings account for medical-related expenses and it has some tax benefits but that was about it. As I dove into the research to understand all the details of an HSA, I realized I had a lot to learn.
There is so much to understand about maximizing the benefits of an HSA account, minimizing any fees, and having it work as a “secret IRA”. I wanted to know why it might be a good choice for me. I wanted to ensure I was getting the most out of my HSA while maintaining my financial foothold.
I had a lot of questions I needed to answer. And who best to answer my questions but you, my FIRE community.
I searched through your blog posts, YouTube videos, and financial articles to find the answers.
In this article, I summarized what I learned and my biggest takeaway from each of my questions. I recommend reading each referenced article for a more detailed answer. Here are my ten questions I wanted answers to when I opened my first HSA.
- HSA Questions and Answers: My Top 10
- #1: What is an HSA?
- #2: How does an HSA affect my taxes?
- #3: How do I open an HSA?
- #4: Can I keep my HSA if I change insurance plans?
- #5: How do I avoid fees or penalties with my HSA?
- #6: How should I invest HSA funds?
- #7: What are the benefits of HSAs?
- #8: Should I use my HSA or save it?
- #9: How should I keep records of qualified medical expenses?
- #10: How do I withdraw my money from my HSA account?
- Potential Downsides of an HSA
- The Secrets of HSA Unlocked
HSA Questions and Answers: My Top 10
#1: What is an HSA?
Answer #1: Defining the term HSA is easy. It is a Health Savings Account. But defining what an HSA can do for your and your financials is a bigger question that I will address later on.
Per the IRS, an HSA is tax-exempt savings account you can use to pay for qualified medical expenses. You can only open an HSA if you meet the following requirements:
- You are enrolled in a high deductible health plan (HDHP)
- No other health coverage is available to you
- You aren’t enrolled in Medicare
- You can’t be claimed as a dependent on someone else’s tax return
For 2021, an HDHP is defined by the IRS as a health insurance plan with an annual deductible that is not less than $1,400 for individual coverage or $2,800 for family coverage. The maximum annual out-of-pocket expenses are capped at $7,000 for individual coverage or $14,000 for family coverage.
Similar to a 401(k), there are annual contribution limits. For 2021, the maximum contribution is $3,600 for an individual and $7,200 for a family. Contributions may be made either by your employer, by yourself, or a combination of the two up to the max.
For a quick HSA introduction video, watch this video below by OurRichJourney:
- A clue to help identify if your plan is eligible for an HSA, the plan name could include HSA. For example Anthem Healthkeepers Bronze X 5900 For HSA
- Not all HDHP qualify for HSA—usually because of out-of-pocket or deductible amounts exceeding IRS limits for HSA eligibility
- Contribution limits change annually so be sure you are referencing the most up to date information
- Contributions can be made annually up to the limit until you sign up for Medicare
#2: How does an HSA affect my taxes?
Answer #2: Contributions to an HSA are deductible reducing your federal and state tax burden, similar to 401(k) contributions. HSA are savings accounts that may accrue interest and may allow the funds to be invested. This growth in your HSA is tax-free. Also, withdrawals from an HSA are tax-free when used on qualified medical expenses. This is known as The Triple Tax Benefits Of The HSA as ChooseFI puts it.
Mad Fientist also points out that if you contribute to your HSA through payroll deduction, you avoid paying FICA taxes on these contributions.
- Maxing out your HSA can lower your MAGI to qualify for a health insurance premium subsidy
- Invest your HSA funds to get a 3rd tax advantage of tax-free growth
- In some states, HSA growth is only tax-deductible on your federal income taxes
#3: How do I open an HSA?
Answer #3: If you are self-employed or do not have an employer-sponsored plan you can choose any HSA provider you want just like any other bank account. I reviewed Investopedia‘s Best Health Savings Account (HSA) Providers for 2021 which summarizes the pros and cons of each one. I chose HSA Bank as my HSA provider because there is no minimum account balance and the investment options with TD Ameritrade.
The application to open an HSA was simple and took only about 10 minutes to complete. Once my account was confirmed, I could contribute to my account. With my HSA provider, I can choose to add funds to my HSA via an online transfer from my bank account, mail a check or money order, or by payroll deduction if I had an employer-sponsored health plan. A fourth option is to rollover funds from an existing HSA or MSA (medical savings account).
I chose to link my bank account and max out my HSA all at once. You will need to link your bank account to the HSA and wait for the test deposits to be confirmed. Once setup is complete, you can deposit up to $3,600 (in 2021) right away.
If you do not want to max out your account all at once, there is an option to set up reoccurring deposits. As is my intention in future years, your HSA funding should become part of automating your finances. I wrote an article about how to automate your finances recently that details the system I created.
- It is your responsibility to ensure you qualify to open an HSA and to stay below the annual contribution limits
- If you are not happy with your HSA provider under your company-sponsored HDHP you can change your HSA provider but may lose the advantages of payroll deduction
- HSAs may not be a good choice for you depending on your healthcare expenses and financials and only you can decide if it is right for you
#4: Can I keep my HSA if I change insurance plans?
Answer #4: Yes, you own your HSA and all of the money in the account. You can still withdrawal funds for qualified medical expenses for life. The only rule is once your insurance plan changes to a non-HDHP, you may no longer make contributions to your HSA.
If this happens to you, you can still invest any remaining cash in your HSA to let the money grow tax-free until you need it.
- Be aware of the type of health insurance plan you have and know when to stop making contributions
- Unlike a FSA, funds in an HSA roll over year to year and the money is yours to keep
#5: How do I avoid fees or penalties with my HSA?
Answer #5: To avoid or limit fees with your HSA, read the terms of your HSA before you open your account.
You may have a monthly HSA service fee that may be waived with a minimum account balance. At HSABank a monthly $2.50 fee is waived if the daily account average exceeds $2,999.99. If you do not deposit at least $3,000 when you open your account, it may take a few months to reach this threshold.
You can’t escape all fees. All HSA providers that have investment options will charge some type of investment fee. Your HSA provider may have an annual maintenance fee in addition to any expense ratios on the investments you choose.
Once you start to use your HSA, only withdraw funds from your HSA to pay for qualified medical expenses per the IRS. These types of distributions are tax-free as long as you report it on your taxes using Form 8889. Therefore, it is imperative you keep excellent records of all your medical expenses with an HSA.
If you must access your HSA funds for non-medical costs before the age of 65, be prepared for a 20% penalty plus income taxes on the distribution.
Once you reach the age of 65, you may withdraw your funds without penalty but you will have to pay income tax. However, the tax savings benefit still applies for withdrawals used for qualified medical expenses, meaning you will not have to pay taxes on these distributions.
Check out The FI Tax Guy who helped me understand how to avoid fees and taxes with an HSA.
- Research your HSA providers fees before opening your HSA
- Keep excellent records of your medical expenses for tax purposes and delayed distributions
#6: How should I invest HSA funds?
Answer #6: This was my biggest question about my HSA. My main concerns were that my money set aside for healthcare expenses would get lost in the stock market or I would pick poor investment options and miss out on additional tax-free growth. These are both valid concerns that you will need to consider when investing your HSA funds.
To get the most out of the tax-free growth in your HSA, you need to invest in something. According to the Employee Benefits Research Institute (EBRI), only 7% of HSA account owners had investments other than cash.
Similar to your other investment accounts, you should pick investment options that align with your goals and risk tolerance. Before choosing an HSA provider, research their investment menus to see what they have to offer. Your HSA options are typically limited to mutual funds, ETFs, stocks, and bonds. The Motley Fool reviews the pros and cons of HSA investment options to help you make your decision.
Mutual funds, ETFs, or stocks have higher risks. If you’re unfamiliar with the difference, Chris wrote a few excellent articles that explain the differences: investing in ETFs vs stocks, individual stocks vs index funds, and VTSAX vs VTI (which explains how mutual funds relate to ETFs).
Once you are close to retirement or have expected upcoming medical expenses, you may consider reducing your investment risk to diversified index funds or bonds. You don’t want to be caught without enough cash to cover your medical expenses.
- Invest your HSA funds—don’t be a part of the 93% of HSA owners that miss out on tax-free growth
- Investing is a personal decision, do your own research to decide what is the best option for you
#7: What are the benefits of HSAs?
Answer #7: There are many benefits of an HSA. The most notable one is the triple tax advantage I discussed in question #2.
Mad Fientest explains how HSAs are actually super IRAs in disguise because HSAs have the benefits of both a Roth IRA and a traditional IRA. See his post for more detail.
To take full advantage of your HSA, he recommends maxing out your HSA annually. This reduces your taxes. Then invest the balance in low-cost index funds. This will let your money grow tax-free for years until you must access it.
You can make tax-free distributions whenever you want as long as you’ve had a qualifying medical expense after opening your HSA. The concept of delaying your HSA distributions, which I will explain further in question #8, allows your money to be invested and continue to grow tax-free.
Once you reach age 65, your HSA essentially becomes like an IRA with the added benefit that you can use the HSA to pay for Medicare premiums and other medical expenses tax-free.
Another benefit of HSAs is they do not have a required minimum distribution (RMD). This allows you to take out your money only when you need it.
Most often HDHPs that qualify for an HSA have lower monthly premiums. Of course with HDHPs, you will pay more upfront before your insurance kicks in.
- Don’t let your HSA just sit around—invest the funds to grow the account balance
- Keep detailed records of your medical expenses and associated distributions
- Your HSA may have a maximum daily distribution limit
- Once you reach age 65, you have fewer limitations with your HSA funds
#8: Should I use my HSA or save it?
Answer #8: After reading countless posts all over the web about whether or not to use your HSA to directly pay for medical expenses, the general consensus is no. Instead, pay for your medical expense with a non-tax advantaged account and save your receipt. This will allow you to save your HSA funds and allow them to continue to grow tax-free until you absolutely need to access them.
There is no time frame for reimbursing yourself from your HSA for qualified medical expenses. As long as you keep detailed records of your receipts you can take a delayed distribution from your HSA tax-free at any point in the future. The money you withdraw from a previously paid medical expense is added to your pocket without increasing your income.
A tip from Mad Fientist is to pay for medical expenses with a credit card—one that earns rewards—instead of the HSA. Since you can choose when you want to pay yourself back, you can do it right away to pay off the credit card or let it simmer in your HSA investments earning tax-free growth.
Money Under 30 describes how your HSA can help you meet your FIRE goals. This special savings account is not only a dedicated account for any medical costs but can also double as an additional stash of money growing tax-free. It can be accessed at any time during early retirement assuming you have a medical expense receipt to cash-in.
Note that if you itemize a medical expense that you pay without using your HSA, you may not later use this medical expense receipt to take a delayed distribution from your HSA. This would be considered double-dipping. You should make careful notations and records of all health-related expenses and HSA distributions.
- Use your HSA if you do not have sufficient funds to pay for your medical expense
- Save your medical receipts to cash in tax-free whenever you want
#9: How should I keep records of qualified medical expenses?
Answer #9: By the time you decide to dip into your HSA, it may be years from the time of your medical expense. I highly recommended keeping digital backup copies of all your medical expenses and receipts. Not only will you want to have records of your paid medical expenses to cash in at a later date, but you will also need to have documentation of any HSA distributions taken for medical expenses for your tax records.
First, you will want to ensure your expense is a qualified medical expense per the IRS. It is a good idea to record the year of the expense as the list of qualified medical expenses may change over time.
In addition to making digital scans of medical expense receipts, download any related EOBs or statements associated with the expense now. Do not rely on a website being maintained 30 years from now when you are trying to get your distribution.
Use a spreadsheet to record how much and when the medical expense occurred. Record how it was paid, either with or without HSA funds, along with the file name of any scanned documents. Lastly, record if it is eligible for delayed distribution and when you cashed it in.
- Develop a system to track your expenses and stick to it
- Make a backup of your medical expense records
- Your HSA provider may have an expense tracker tool available
#10: How do I withdraw my money from my HSA account?
Answer #10: You can only withdraw funds from your HSA cash account. If you do not have enough funds in your HSA cash account, you may need to transfer funds from your brokerage account. You are limited to transfer the funds in the liquid balance of your brokerage account and may need to sell some of your investments to reach your desired amount. Fees may apply.
With my HSABank account, you can pay for qualified medical expenses with your HSA debit card as long as there are enough funds in your cash account. If your expense exceeds the daily limit, you have a few options. You can pay the provider directly through the HSA provider’s Bill Pay website, pay over multiple days, or pay with a personal account to be reimbursed at a later date.
Any qualified medical expenses paid out-of-pocket that you which to be reimbursed by your HSA can be withdrawn directly to your bank via online transfer or via check. Alternatively, if you have an HSA debit card, you can use your card at an ATM to reimburse yourself, but transaction fees will most likely apply.
You are required to keep records of any HSA distribution and attest the distribution is for a qualified medical expense.
- Selling investments and transferring funds will take some time
- You may have a minimum cash balance before you can invest
- You may have a daily maximum debit or transfer limit to avoid fraudulent activity
Potential Downsides of an HSA
It is important to keep in mind the basic principle of an HSA, it is a health savings account for high deductible health plans. This special account was designed to set aside money for high medical expenses. HSAs may not be right for you.
Tanya with Our Next Life remarks that HDHPs have gotten out of line with the HSAs. Most qualified HDHPs have deductibles that are dramatically higher than the HSA annual contribution limit. My plan has a $5,900 deductible meaning I may have to come up with another $1,500 before my insurance even kicks in during this first year of my HSA. Not to mention I will still have to reach my out-of-pocket max of $7,000.
Even if you have the means to afford your healthcare costs without spending your HSA funds, you may think twice before going to the doctor. Any delay in a trip to the doctor may lead to a healthcare emergency or reduced quality of life. Remember to use your insurance for what it is there for, taking care of your health. Even if you are a millennial who isn’t a heavy user of health care be sure to take advantage of any no-cost preventative care services to lead a healthy life during your early retirement.
My point is to understand all the secrets of your HSA, the tax benefits, and the financial limitations it poses. Evaluate your healthcare needs and run the numbers to see if it’s right for you.
A great place to start if you are completely new to HSAs, is over at the Mad Fientist who provides a great overview of HSAs in his article HSA – The Ultimate Retirement Account.
The Secrets of HSA Unlocked
Defining my top 10 HSA questions and answers for this post taught me a lot. I now have the information I need to invest and make the most of this triple-tax-advantaged account. It should help you, or someone you know, get their head around HSAs when opening their first account.
Already this year I’ve taken one tax-advantage of my HSA. I chose an HDHP with HSA and maxed-out my 2021 contribution, lowering my taxable income. With this reduction, I qualified for a healthcare premium subsidy. That’ll help us stay a little closer to our annual FIRE budget even though we now have to budget for my monthly insurance premiums.
Yet, I have also already made a mistake. I used my HSA to pay for a medical expense even though I had the means to pay for it otherwise. But what other way to learn from your mistakes than to live through them.
Now I fully understand the hidden secrets of HSAs and instead will keep paid medical expense receipts to cash in later in life when I really need the money. This will allow my HSA funds to grow tax-free, taking advantage of the second tax benefit.
Now all I need to do is actually invest my HSA funds so I can be part of the 7% of people who invest their HSA funds.
Do you have an HSA? If so, are there still questions you don’t know the answers to when it comes to the details of how they operate? Let me know in the comments!