What is an HSA and should you have one?

When preparing for the future, many people automatically think about covering the basics, such as food and housing, and maybe travel plans or other pleasurable activities to enjoy after decades of hard work. But there is another important cost to consider when planning ahead: medical expenses.

Unexpected health care costs can drain your nest egg. But a health savings account (HSA) is an investment tool that can help you manage your medical expenditures now and in the years to come.

What is an HSA exactly?

An HSA is a savings account specifically for medical expenses. It allows you to stash money away for costs related to the prevention, diagnosis and treatment of health issues—everything from eyeglasses and Band-Aids to co-pays, prescriptions and medical procedures.

Even better news: HSAs can be funded with pre-tax dollars. That means you can set aside a certain percentage of your paycheck to be allocated to an HSA, reducing your taxable income.

And like company-sponsored 401(k) retirement plans, employers can make contributions to your HSA for additional savings. You can also claim a tax deduction for any contributions you make.

Some HSAs also pay interest or enable your contributions to be invested in mutual funds, allowing them to grow over time. Any interest or earnings on HSA funds are also tax-free. So, the money goes in tax-free, grows tax-free and comes out tax free—as long as it’s used for qualified medical expenses.

Another major advantage of having an HSA is that your contributions remain in your account indefinitely—or until you need them.

Unlike flexible spending accounts (FSAs), which typically require people to use funds within a certain period of time or limit the amount of funds that can carry over from one year to the next (usually no more than $500 per year), the money you put in an HSA doesn’t need to be spent within a specific timeframe. So, even if you leave your job or retire, any unused money will remain in your account year after year.

Who is eligible?

In order to open an HSA, you must meet certain requirements. First, you must have a high-deductible insurance plan that is HSA-eligible.

For these plans, people typically pay lower monthly premiums but must pay more out of pocket than a traditional plan before medical costs—other than preventive care—are covered by their insurance.

For the year 2024, the minimum deductible for an individual high-deductible plan is $1,600 and jumps to $3,200 for a family.

You only qualify for an HSA if this is your only health insurance and you have no additional coverage, including Medicare. Keep in mind you can still have an HSA if you have separate dental, vision, disability or long-term care insurance.

Other requirements to be eligible for an HSA:

• You must be younger than 65 years old (most Americans lose HSA eligibility at age 65 when they begin Medicare)
• You cannot be claimed as a dependent on someone else’s tax return
• You cannot also have an FSA unless it’s a limited purpose, or “HSA-compatible” FSA that can only be used for vision care and dental expenses

Are there possible downsides?

Similar to other investment tools, there are consequences for using HSA funds for anything other than qualified medical expenses. If you use HSA funds on anything that doesn’t qualify, you will face a 20 percent tax penalty. An unqualified withdrawal is also considered taxable income so it’s a double whammy.

By the age of 65, however, you can use your HSA dollars any way you see fit without this 20 percent penalty. But if you use them on nonmedical expenses, your withdrawals will still be taxed as ordinary income.

It’s important to track HSA expenditures and to keep your receipts with your tax records. Also to note: HSA funds can’t be used to pay your health insurance premiums unless you’re older than 65. You can also be penalized for contributing more to your HSA account on a yearly basis than is allowed by the Internal Revenue Service (IRS).

For 2024, individuals with a high-deductible health care plan can contribute up to $4,150. Those with a high-deductible family plan can set aside up to $8,300 for an HSA. This total includes both individual and employer contributions.

People aged 55 years and older are allowed to set aside an additional $1,000 annually in “catch up” HSA contributions to help cover their medical costs in retirement. Once enrolled in Medicare, however, people are no longer able to contribute to their HSA.

Should you get one?

Saving money to cover your health care expenses is wise, particularly if you’re nearing retirement. If you’re eligible for an HSA and wondering if this investment tool is right for you, it’s a good idea to consider your monthly expenses.

Planning for your future is rarely a bad thing, unless it places undue financial strain on your current budget.

If you’re unsure of what’s right for you and your family, consult with a certified financial advisor who can walk you through your options and help you determine the most effective way to secure your financial future and protect your long-term health.