What is a Health Savings Account (HSA)?

Think of an HSA as a combination of health insurance and a savings account...

You’re essentially self-insuring against a future medical emergency. The list of expenses eligible for your HSA covers even more than most health insurance plans — that includes deductibles, copays, dental and vision expenses, and alternative medicine.

The IRS regulates Health Savings Accounts, so to qualify for an HSA, you must meet the following requirements, as set out by the IRS:

• You have healthcare coverage under a high-deductible health plan (HDHP)
• You do not have any other health coverage.
• You are not enrolled in Medicare.
• No one can claim you as a dependent on someone else’s tax return.

The IRS also sets guidelines for what qualifies as a high-deductible health plan. For 2023, an HDHP is any plan with a deductible of at least $1,500 for an individual or $3,000 for a family (up from $1,400 for an individual and $2,800 for a family in 2022).

You might be wondering whether an HSA is the right choice for you. As with many other healthcare decisions, there are plenty of pros and cons to break down.

Advantages of an HSA:

• You have better prepared yourself for an emergency if you are on a high-deductible health plan.
• The money going into your HSA (both from you and your employer) is not subject to federal taxes and in some states not subject to state income taxes (CA does not recognize HSA for example).
• Your employer may contribute to your HSA — These contributions are also tax-free.
• You can bring your HSA and the money in it from one job to another.
• Unused money in your HSA rolls over every year — It’s yours forever.
• You can invest the money in your HSA — Any potential earnings are also tax-free.

Disadvantages of an HSA:

• If you don’t have many medical expenses, the money may be better spent elsewhere.
• You may not have room in your budget to set aside money for an HSA.
• If you use the money in your HSA for an ineligible expense, you’ll pay both income taxes and a 20% fee.

Ultimately, it’s essential to take control of your health and your finances. No one knows your situation better than you do.

HSAs can be an excellent safety net for people with a high-deductible health plan. If you have a high-deductible plan but don’t expect to need it, an HSA is certainly something to consider.

If on the other hand you generally require a lot of medical care, the tax benefit might not outweigh having to pay the high deductible every year.

So you’ve got the lowdown on HSAs and have decided this is the right choice for you. The question now is, how do you start one?

If you meet the qualifications put in place by the IRS, you can start your HSA anywhere that offers the service. You can set it up with a bank, a credit union, an insurance company, or a broker or advisor.

It's worth doing some research before going the HSA route. Different institutions will have different administrative fees and investment options. Different employers will make different health plans available to their employees, so you can check to see what investment options are available to you.

As soon as your HSA is set up, you can start contributing, though there is an annual contribution limit. The limit in 2023 is $3,850 for individuals and $7,750 for families.

When you receive a medical bill, you can use your HSA to cover the part of the bill not covered by your health insurance. You will also likely receive a debit card, which you can use on other qualified medical expenses.

To have coverage under an HSA, expenses must meet the requirements of qualified expenses. If you use money from your HSA for items that don’t meet the criteria, you’ll have to pay income tax on that money. You may face other penalties as well.

HSA qualified health care expenses include:

• Health insurance deductibles
• Copayments
• Dental services
• Vision care
• Prescription drugs
• Psychiatric services
• Birth control, both prescribed and over-the-counter
• Smoking cessation programs and prescription drugs
• Acupuncture
• Chiropractic services
• Physical therapy
• Contact lens solution

HSA qualified expenses do not include:

• Vitamins
• Gym memberships
• Nicotine gum or patches
• Over-the-counter medications
• Childcare costs
• Diapers
• Toiletries
• Elective cosmetic procedures
• Maternity clothes
• Illegal medical treatments

If there’s ever a time where you aren’t sure if your HSA covers something, it’s vital to seek professional advice. Remember how we talked about the money in your HSA being tax-deductible? Once you spend it on something else, you’re required to pay income tax on it if it is not a qualified expense. Not only that, but you’ll also have to pay a 20% fee on any ineligible expenses. And yes, that’s on top of the income tax you’ll pay on that amount.

If you’re familiar with FSAs (flexible spending account), you may wonder if there’s any difference between the two. Yes, there is.

Both an HSA and FSA are accounts that allow you to save for qualified medical costs. Both also allow you to contribute tax-free. That is mostly where the similarities between an HSA and FSA end.

The first big difference between the two accounts is eligibility. If you’re trying to decide between an HSA and an FSA, this difference might answer your question: there are no eligibility requirements for an FSA. To qualify for an HSA, you must have a high-deductible health plan (HDHP).

Another major difference between the two accounts is that FSAs are “use it or lose it.” This means your balance does not carry over every year. With an HSA, unused balances do carry over.

As we’ve discussed, there are a few significant tax advantages associated with HSAs:

First, contributions to your HSA are not taxed. And as long as you spend the money on qualified medical expenses, it is not taxed when it comes out of your account (except in a state like CA where an HSA is not recognized).

Finally, if you invest the money in your HSA, any growth on that investment is tax-free.

If you have wondered if there was any significant difference between an HSA and a personal savings account, you can see the tax benefits of the HSA can make a huge difference.

An added perk of an HSA is that you can invest that money into mutual funds, ETFs, bonds, and other investment tools.

The investment benefits of an HSA may be even more beneficial than those of a 401k or IRA. With both the 401k and IRA, you are paying taxes on the money at some point. This is not the case with the HSA, when applied to qualified expenses.

It's important to note that investments made from your HSA run the same risk as other investments. This means, should you decide to go this route, there is a chance of losing money.

*Robinhood does not provide tax advice. For specific questions, you should consult a tax professional. *