A health savings account (HSA) is an ideal way to set aside money for future health expenses. Any money you don’t use this year can be used in future years. If your HSA administrator allows, it can be invested so that it can compound and grow like an IRA. Unlike an IRA the money you put into an HSA does not get taxed when you take money out to pay for medical expenses, making it a tax-efficient way to save money for future health expenses.
The longer you go without withdrawing money from your HSA, say your retirement years, the more it can grow, Potential growth in the value of the account makes over time makes them a great way to pay for medical expenses in retirement. In our prior article, FSA vs. HSA: What You Need To Know, we highlighted projected expenses of more than $400,000!
An HSA remains tax free if used to pay for qualified medical expenses. Unlike a 401(k) or IRA accounts, there are no required minimum distributions to deal with.
What health expenses are actually covered by an HSA?
In most cases, an eligible expense would be considered the cost of anything that is designed to return you to a normal state of health. That can be anything from doctor’s bills and prescriptions to eyeglasses and dental fillings. Here’s some examples of eligible expenses:
Acupuncture Alcoholism treatment Ambulance services Artificial limb or prosthesis Artificial teeth Birth control pills Braille books/magazines (portion of costs) Car adaptations (for persons with disabilities) Chiropractors Christian science practitioners Contact lenses (including saline solution and cleaner) Crutches Dental treatment (x-rays, fillings, extractions, dentures, braces, etc.) Diagnostic devices (such as a blood sugar test kit) Doctor’s fees Drug addiction treatment Eyeglasses (including eye examinations) Eye surgery (including laser eye surgery) Fertility enhancement (including in-vitro fertilization) Guide dog (for visually-impaired or hearing-impaired) Hearing aids and hearing aid batteries |
Hospital services (including meals and lodging) Insulin Laboratory fees Lactation assistance supplies Prescription medicines or drugs Nursing home Nursing services Operations or surgery Psychiatric care Psychologist Telephone equipment for hearing-impaired Telephone equipment for visually-impaired Therapy or counseling Transplants Transportation for medical care Vasectomy Wheelchair X-rays |
You can refer to IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans if you have specific questions on covered costs.
Depending on your health insurance coverage, you might even be able to use your HSA to help pay your insurance premiums. For example, if you lose your job and you have to pay for COBRA, you can use the funds from your HSA to pay for COBRA. Although you can’t contribute to an HSA if you’re on Medicare, you can use the funds from your HSA account to help supplement your Medicare coverage.
Taxes and Penalties
If you do decide to withdraw funds from your HSA to pay for any nonmedical expenses (or ineligible medical expenses, such as elective surgery), you’ll have to report that money as taxable income. In effect, this turn the HSA into a traditional IRA. (You still have benefitted from a tax-free contribution and tax-free growth.) The distribution will be added to your income for that tax year. If you’re under the age of 65, you’ll also have to pay a 20% fine for using your health savings account money for a non-health or ineligible expense. If you wait to use it until you over the age of 65, that 20% fine disappears. This is another reason to think of this as a retirement HSA.
Spouses and Beneficiaries
Similar to an IRA, you can and should name a beneficiary for your HSA. For example, if you want to make sure your spouse can access your HSA if they outlive you, you can name them as the beneficiary of your HSA. They can keep the HSA in their own name and can continue to use the funds for qualified medical expenses tax free. While you can name others, it’s less tax friendly because they receive the funds as a lump distribution added to their income in the year received.
Don’t let the details scare you. The upside of triple tax-free benefits for expenses you would have had to pay for anyway can be substantial. You may want to seek professional advice to help you navigate the pros and cons of an HSA, including which expenses you can pay with your HSA. A personalized approach, where a savings, investing and a wealth transfer (HSA transfer) strategy is crafted for you, will likely deliver better results than a generalized one.