Health Savings Account (HSA) Rules and Limits

Does your health insurance come with deductibles in the four figures? If so, you're probably eligible to establish a Health Savings Account (HSA). Used in combination with a High-Deductible Health Plan (HDHP), funds deposited in an HSA can go towards paying medical bills until the plan's deductible is met and your healthcare coverage kicks in.

HSAs were established in 2003 as part of the Medicare Prescription Drug, Improvement, and Modernization Act. These savings accounts have become an increasingly popular option for consumers seeking to manage their healthcare costs. They also work as a tax-advantaged savings tool as well.

Who Can Open a Health Savings Account?

According to the federal guidelines, you can open and contribute to an HSA if you:

• Are covered under a qualifying high-deductible health plan which meets the minimum deductible and the maximum out of pocket threshold for the year
• Are not covered by any other medical plan, such as a spouse's plan
• Are not enrolled in Medicare
• Are not enrolled in TRICARE or TRICARE for Life
• Are not claimed as a dependent on someone else's tax return
• Have not used Veterans Administration medical benefits in the past three months (exceptions apply to veterans enrolled in a high-deductible health plan who either have a service-connected disability or have only accessed disregarded coverage and preventive services in the past three months).
• Do not have any disqualifying alternative medical savings accounts, like a Flexible Spending Account or Health Reimbursement Account

What Qualifies as a High-Deductible Health Plan?

As its name implies, an HDHP is a healthcare plan that trades relatively low monthly premiums for relatively high deductibles. To qualify for an HSA that can be opened in combination with an HDHP, the HDHP must meet certain criteria.

The Internal Revenue Service (IRS) establishes guidelines ever year, adjusting the figures for inflation. Here are the qualifying criteria for tax years 2022 and 2023:

*Note that the out-of-pocket maximum is also designated by the plan. It can include deductibles, co-payments, and co-insurance. It does not include insurance premiums. The out-of-pocket maximum will usually not include out-of-network services.

How Does a Health Savings Account Work?

Contributions to an HSA are tax-deductible. For employer-sponsored plans, the contributions are deducted from paychecks. If you're self-employed, the deductions can be taken when your annual taxes are prepared.

Withdrawals from an HSA are tax-free provided the money is used to pay for qualified medical expenses. These expenses can include payments for dental and vision care, which some medical health insurance plans do not cover.

Most HSAs issue a debit card that can be used to pay for prescription medications and other eligible expenses. If you wait for a bill to come in the mail, you can make a payment over the phone using your debit card.

No Use-It-or-Lose-It Worries

Any money that is in your account at the end of the year remains in your account to pay for future qualified medical expenses. End-of-year balances are carried over indefinitely.

The account and its funds belong to you, and you retain ownership even if you change health insurance plans, change jobs, or retire. While it's in the account, the money grows tax-free.

How Much Can I Contribute to a HSA?

The IRS sets limits that determine the combined amount that you, your employer, and any other person can contribute to your HSA each year:

• For 2022,the maximum contribution amounts are $3,650 for individual coverage and $7,300 for family coverage.
• For 2023, the maximum amounts are $3,850 for individuals and $7,750 for family coverage.
• You can add up to $1,000 more as a "catch-up" contribution if you are age 55 or older.

How Can I Use HSA Money?

The money in your HSA can be used to pay for qualified medical expenses incurred by you, your spouse, and your dependents. The IRS establishes what is and what is not a qualified medical expense, detailed in IRS Publication 502, Medical and Dental Expenses.

Qualified expenses include nearly any medical cost you may incur, including payments for diagnostics, cures, mitigations, treatments, and prescribed preventative medications.

One of the great benefits of the HSA is that it can be used to make payments that count toward your deductible.

Moreover, the HSA is a tax shelter, meaning you won’t pay income taxes on the money you contribute. This saves you the taxable amount while allowing you to put those funds towards medical expenses that you would probably have otherwise paid with after-tax dollars.

Filling Gaps in Health Plans

Remember that you can also use the account for expenses that aren't covered by your health insurance plan. For example, if your medical plan doesn't cover dental or vision care, HSA funds can still be used for those bills.

There are a few things that an HSA cannot be used for. You can't use it to pay insurance premiums. Other ineligible expenses include over-the-counter items like toothpaste, toiletries, and cosmetics, as well as most cosmetic surgeries. A vacation to a healthier climate would also not qualify.

If you're 64 or younger and withdraw funds for a non-qualified expense, you'll owe income taxes on the money, plus a 20% penalty. If you're 65 or over or are disabled, you'll still owe taxes on the amount but will be spared the penalty.

So, frankly, after age 65, you can essentially withdraw HSA funds for anything.

How Can I Set Up a HSA?

You first need to enroll for an HDHP. If you take that step through your employer's human resources department, it should be able to advise you on creating your HSA. Most employer-sponsored HDHPs have an associated HSA provider for you to work with.

If an HSA does not come with your HDHP, you can set up the account on your own. Banks, credit unions, and brokerages all offer HSAs. Each HSA provider can create its own terms. HSAs through a brokerage even allow you to invest your contributions in stocks, bonds, or funds. Bank HSAs will usually offer an optimal interest rate.

Once you select a provider, the enrollment process is fairly straightforward: You will be required to complete an application with information on your HDHP. Once your account is approved you can fund the account and begin using it for qualified expenses.

HSAs As Savings/Investing Tools

An HSA can be used as a tax-sheltered investment vehicle. For savvy investors, they create an opportunity to accumulate capital gains that can be withdrawn tax-free for medical expenses.

Most HSA account holders will want to be somewhat conservative in investing this money since it is intended for necessary medical costs. This can limit the types of investments an account holder may want to make with their HSA contributions to mostly low-risk products like highly-rated bonds.

The type of account opened will dictate the type of investments that may be available. Plans provided through banks usually offer only high-yield savings deposits. Brokerages offer much more. Some of the top HSA investment platforms include Vanguard, HSA Bank/TD Ameritrade, Lively, Optum Bank, and HealthSavings Administrators.

Who Benefits Most From a HSA?

High-deductible health plans make the most sense for people who are relatively healthy with minimal expectations for their annual healthcare needs. HDHPs offer lower premiums in return for higher deductibles that would need to be paid if an emergency arises.

This is what makes the combination of an HDHP and HSA very beneficial. Plan owners can potentially save indefinitely through an HSA for emergencies that may require a high deductible payment.

HSAs and HDHPs can also appeal to high-income earners as well as people nearing retirement age. High earners choosing an HDHP can use an HSA to save up to $7,300 per year in a tax-sheltered account.

The HSA as a Retirement Savings Vehicle

For both high-income earners and those approaching retirement, the HSA can be a worthwhile vehicle for building a medical emergency fund while also saving in a type of alternative retirement vehicle.

On the other hand, keep in mind that if you incur substantial health costs for standard medical care, the high-deductible health plan required to open an HSA might not be the right choice for you. Even though you will pay less in premiums with the HDHP, it could be difficult—even with money in an HSA—to come up with the cash to meet the deductible for a costly medical procedure.

The Bottom Line

If you have a high-deductible health insurance plan, having a Health Savings Account can give you some peace of mind regarding unexpected (and uncovered) medical expenses.

Better yet, any money in your account that you don't have to use will continue to accumulate tax-free over time. In the long run, your HSA can turn into a separate stream of retirement income.