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Should You Consider a Health Savings Account?

Are HSAs worthwhile, and can I open a health savings account on my own? If you have access to one, an HSA can be a powerful savings tool.

March 14, 2022

It’s no secret that health care in America is expensive. In fact, the per-capita (per person) spending is over $12,530 annually — and growing steadily each year. 

One tool intended to make health care more affordable is called a health savings account, or an HSA. 

But is an HSA worthwhile? How do I use one? 

And can I open a health savings account on my own? 

What is a health savings account? 

A health savings account is a type of savings account that allows you to set aside money before paying taxes on that money. If the funds are used for a medical expense, you won’t have to pay tax when you withdraw them. 

You can think of an HSA as a type of specialty savings account that is designed to help you save for health care costs. 

Money in an HSA can be invested — but not by default. You’ll need to log into your HSA account to make investments in stocks and other assets. 

Are HSAs worth it?

In short: Yes. There are significant advantages to using a health savings account:

  • Money you put in is pre-tax, which means you don’t pay income tax on it

  • Money can be invested and grow tax-free over time

  • Any future withdrawals used to pay for medical expenses are also tax-free

HSAs are designed for medical expenses. If money is withdrawn from an HSA to pay for non-medical expenses, a 20% tax penalty may apply (along with regular income taxes). 

Example of HSA savings

Let’s look at an example of the power of HSAs. 

Rebecca is 45 years old, earns $65,000 per year, and lives in Oregon. Her federal income tax bracket is 22%, and her state income tax is 8.75%. 

She has an HSA-qualified health plan through her workplace. Rebecca decides to contribute $3,000 per year ($500/month) to her HSA. 

Each year, Rebecca will have upfront savings of:

  • $660 of federal income tax (22% of $3,000)

  • $262.50 of state income tax (8.75% of $3,000)

That’s a total of $922.50 she won’t have to pay in taxes, each year

But that’s just the upfront savings: Remember that HSA funds can be invested and grow tax-free. 

Rebecca invests the money in her HSA in stock market index funds, which grow at an average rate of 10% per year. 

After 10 years (of continuing to invest $3,000/year), her account has grown to around $55,500. 

After 20 years, when she’s retirement age, the balance will have grown to over $192,000. 

As long as she eventually uses these funds for qualified medical expenses, she can withdraw the funds and pay nothing in taxes. 

Most of us will have significant medical and/or long-term care expenses when we get older, so an HSA can provide powerful savings. 

But what if you never have huge medical expenses? 

HSA funds for non-medical expenses

Here’s a little-known HSA hack: Once you turn 65, you can withdraw HSA funds for anything without a tax penalty.

You’ll pay regular income tax on the withdrawals, but there is no penalty as long as you’re over 65. 

Plus, many people tend to have a lower income level — and therefore, a lower tax bracket — once they retire. This means you may not end up owing much in taxes. 

To recap:

  • If you use HSA funds (at any age) to pay for qualifying medical expenses, withdrawals are tax-free

  • If you use HSA funds for non-medical expenses before age 65, withdrawals are taxable and subject to a 20% penalty 

  • If you use HSA funds for non-medical expenses after turning 65, withdrawals are taxable, but there is no penalty 

It’s still best to use HSA funds for medical expenses because then you get the benefit of tax-free withdrawals. 

But knowing that you can use HSA funds for anything after age 65 is a great backup plan. Just be sure to plan for income tax on the withdrawals. 

When a health savings account makes sense

Here’s when it makes sense to utilize an HSA:

When you expect to pay for medical expenses soon

HSAs offer immediate tax savings because any funds you put into them are pre-tax. So, even if you have a medical expense in the immediate future, having money in your HSA is quite beneficial. 

And if you end up not having many out-of-pocket medical expenses, you can simply keep the money in your HSA for a future expense. 

When you want to prepare for future medical/long-term care costs

Most people will face medical costs in their life; older adults generally face higher costs. While some expenses may be covered by private insurance and/or Medicare, there will usually be some out-of-pocket costs to cover. 

Long-term care is particularly pricey and can cost $3,600 to $7,600+ per month. 

Regularly contributing to an HSA helps you prepare for these future expenses — while earning valuable tax breaks each year. 

When you want to save for retirement 

As explained above, HSA funds can also be used for general retirement expenses once you hit 65. You’ll have to pay income tax on withdrawals, but this is a great backup option if you don’t end up having significant medical expenses. 

When your finances are on track

If you’ve paid off your high-interest debt and maxed out your retirement accounts each year, using an HSA is a great way to further increase your financial security. 

When to avoid health savings accounts

HSAs are great, but they’re not for everyone. Here’s when they are best avoided:

When you don’t qualify for one

If your current health insurance plan doesn’t qualify for an HSA (see details below), you won’t be able to open one or contribute to it. 

When you have other financial priorities

We all have a limited amount of funds available to us each month — and sometimes, we must prioritize the most important items first. For instance, if your bills eat up all your monthly income, opening an HSA won’t necessarily help you much. 

Likewise, if you’re behind on retirement savings, contributing to retirement accounts should likely be a higher priority than saving in an HSA.

When you have high-interest debt

If you have high-interest debt, such as credit card debt, paying this off should be a top priority before contributing to an HSA. Note that this doesn’t include so-called “good debt,” like a mortgage. 

For readers with credit card debt, take a look at Tally†. Tally helps qualifying Americans get out of credit card debt faster and pay less interest along the way offering a lower-interest line of credit. 

When you have excellent health insurance

If you have an excellent health insurance plan through your workplace (and expect to have it in the future), you may not have many out-of-pocket medical expenses. In this case, it may be more beneficial to put any extra savings into retirement accounts, rather than into an HSA. 

Can I open a health savings account on my own?

Many people get health savings accounts through their employers. But what if your workplace doesn’t offer one? Can you open a health savings account on your own? 

The short answer is yes, you can — but only if you have a qualifying health insurance plan. 

What health plans qualify for an HSA?

To qualify for an HSA, you need to have a High-Deductible Health Plan (HDHP). In 2022, this means any health plan with:

  • A deductible of at least $1,400 for an individual or $2,800 for a family

  • Total annual out-of-pocket expenses of less than $7,050 for an individual or $14,100 for a family (this amount includes deductibles, coinsurance and copayments).

These amounts are adjusted annually. Check for the most recent information. 

Also, you cannot contribute to an HSA if you are covered by another non-HSA approved health plan

For example, if you have coverage via your spouse’s plan and that plan isn’t HSA-eligible, you can’t contribute to your HSA — even if your plan technically qualifies. The same is true if you are covered by Medicare or Medicaid. 

Wrapping up

Health savings accounts offer significant tax savings and help you prepare for future medical expenses. For most people, HSAs are very beneficial. If you qualify for one, you’ll likely benefit from using it. 

†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.