Similar to a traditional savings account, the money in a health savings account grows tax-free and may only be spent on certain medical costs. It would help if you had a high deductible health insurance policy to qualify. Although HSAs offer certain tax benefits, they are not without their own set of drawbacks.

When you put money into a health savings account, it doesn't cost you any taxes right away. Direct deposits into your HSA are exempt from taxation. Because of this, you may be able to reduce your yearly tax liability.

However, withdrawal fees might significantly reduce their value if you don't use your HSA funds wisely. If you use your HSA funds for anything other than eligible medical costs, you'll have to pay income taxes on the withdrawal plus a 20% penalty if you take it out before you reach 65.

Learn About Health Savings Accounts

Let's start with the fundamentals. If you have high-deductible health insurance and want to save aside money tax-free for future medical costs, you can open an HSA. These funds can then be used to cover necessary medical care.

Should You Get a Health Savings Account?

Considering the tax benefits associated with these accounts, it's possible. Because HSA contributions are not subject to taxation, you can save money using one to pay for healthcare costs rather than drawing from your regular checking or savings account. Put another way, your employer won't take out tax withholding from this payment. However, not everyone can benefit from an HDHP. The rates for HDHPs are cheaper than those of other types of health insurance, but the yearly deductible is greater.

When Does an HSA Balance Expire?

No. Any contributions you make to your HSA will be safe and secure in the account indefinitely. This implies that any HSA funds left over at the end of the year can be used to pay for medical costs in the following year. In contrast to FSAs, where funds accumulate until expended, they can be used over time.

HSA Money: What Can You Spend It On?

You can avoid paying taxes on those funds if you utilize your HSA withdrawals for medically necessary expenses. Deductibles, dental care, eye care, prescription medicines, co-pays, psychiatric care, and other out-of-pocket costs that are medically necessary but not covered by health insurance are all on the list of allowable expenditures. The Coronavirus Aid, Relief, and Economic Security Act enacted in 2016 made these more accessible.

HSAs Have Several Benefits

Below, we'll go through some of the tax benefits that HSAs provide.

Quite a few Expenses Are Eligible

Medical, dental, and mental health care treatments are all examples of allowable costs. You may find all the information you need about them in IRS Publication 502, Medical and Dental Expenses.

Help from Others Is Possible

Your HSA can receive money from your company, family, and friends. However, restrictions are imposed by the IRS. For 2021, the maximum allowable contributions are $3,600 for single filers and $7,200 for families, with an extra $1,000 catch-up contribution available to those who will have turned 55 by the end of the year. As of 2022, the maximum for single coverage will be $3,650, while the maximum for family coverage will be $7,300.

Investing Before Taxes

Payroll deductions at work are a common way to contribute without paying taxes on the money first. Put another way, and tax withholding won't be taken out of this payment by your employer. Because of this, you do not have to report them as part of your gross income, and they are exempt from taxation by the IRS.

The Downside of Health Savings Accounts

There are certain drawbacks to having an HSA, even if you are eligible for one.

Essential High Deductibles

It would help if you had a high-deductible health plan to open a health savings account, but this plan may be more expensive than others. Even if you have money set up in an HSA, it may be tough to find the funds to satisfy the deductible for a pricey medical operation, despite paying lower monthly rates.

Constraints on Attempting to Rescue

Some people may put off getting medical attention even though they're sick because they don't want to squander up their health savings account funds.

Summary

The tax benefits of an HSA and the option to roll over unused funds are attractive features if you are enrolled in an HDHP. However, HDHPs aren't always the most excellent solution, especially if you anticipate having substantial healthcare bills.