You might have heard this question many times: How does an HSA work when I go to the doctor? Well, the answer is pretty simple, but hold your horses and stay with us to get the answer and learn a lot more. Since they were first introduced in 2004, health savings accounts (HSA) have gained a lot of popularity. The increase in their enrollment is not that difficult to understand; especially, when you consider the way HSAs work and the wide array of benefits they provide to people who are willing and able to take advantage of them.
If you want to contribute to an HSA plan, you must have health insurance coverage with a high deductible through your employer or on your own. You can have an HSA and HDHP even if you buy your own health insurance. It’s not necessary to involve an employer. As soon as you enroll in an HDHP, you can open an HSA (or sign up for the one your employer uses) and start to make contributions.
And if you’re not sure about whether it’s the right move, here are some of HSAs benefits to consider:
First, contributions to an HSA are reported on your 1040 as adjustments to your income (or pre-tax if you contribute through your employer’s payroll). This means you don’t have to pay taxes on the money you put into your HSA. Second, the money in your HSA could earn tax-free interest or investment returns. Third, your withdrawals are tax-free if you use the money for eligible medical expenditures. A health savings account offers more tax advantages than any other type of savings.
Using your HSA for prescription drugs is a wise way to use your resources and can save you money. You can spend money from your HSA on “qualified medical costs,” which may cover more services than you think. Dental cleanings and treatments, vision examinations and glasses, prescriptions, vaccines, and other medical expenses are all eligible.
You’ll have to pay a 20% penalty on top of your income tax if you take money out of your health savings account before you turn 65 and if you don’t use it to pay for eligible medical expenses. But you don’t have to pay that 20% penalty once you turn 65. You can keep using your HSA funds for medical expenses and avoid paying taxes on withdrawals. However, if you decide to use the money for something else, you’ll only have to pay your income tax. It works the same way a traditional IRA works. Note that you can start withdrawing money penalty-free from an IRA at age 59.5, although you must be 65 to withdraw money from an HSA. On the other hand, you don’t have to start drawing money out of your HSA insurance when you turn 72. You can leave it in the account and let it grow.
There are no income limits — at the low end or the high end – for deducting HSA contributions, so think of it as a backup retirement account. For IRAs, this is not true: If you also have a retirement plan at work, there is an income limit for Roth IRA contributions and an income limit for being about to contribute pre-tax money to a traditional IRA. Additionally, both require that you (or your spouse) earn enough income to cover the contributions. However, to contribute to an HSA, you just need to be covered under an HSA-qualified high deductible health plan (HDHP) without any other major medical coverage, and you can’t be claimed as a dependent on another person’s tax return regardless of your income.
In an HSA, you can’t lose what you’ve got if you don’t use it. This is one of the biggest differences between an FSA and an HSA. The money you put in your HSA banking will remain in the account if you don’t withdraw it so that you can use it in future years for unexpected emergencies.
You can keep your funds in basic interest-bearing accounts – similar to regular savings accounts at a bank or credit union. Or, you can invest your HSA funds in stocks, bonds, or mutual funds if your HSA custodian allows it. There isn’t a single right answer for what to do with your funds before you need to use them. An FDIC-insured institution might be the best option if you plan to withdraw most or all of your HSA contributions each year to fund ongoing medical expenses. The account will probably generate only small amounts of interest, but it’ll be protected from losses.
If, however, you intend to invest your HSA insurance in the long run and you’re comfortable with stock market volatility, investing your funds will likely meet your needs. Know that most HSA owners don’t invest their funds. You can choose from any of the available HSA custodians if you buy your own HDHP. If you have an HSA plan through your employer, you might only be able to use the custodian chosen by your employer. And HSA contributions made through payroll deduction are normally free of payroll tax and income tax. If you contribute to your HSA independently, you cannot avoid payroll taxes. However, you’re free to set up a separate HSA insurance on your own and transfer money out of the one your employer selected and into the one you choose for yourself. Since the IRS considers this a transfer, and not a rollover, you can do this as often as you like.
The money you put into an HSA through your employer is yours. If you leave your job, you can take the remaining balance with you. Another difference between HSAs and FSAs is this. You can also choose a new HSA custodian and transfer the funds. When you leave your job, you don’t have to pay taxes on the money you take with you unless you take the money out and don’t use it for medical expenses.
Clearly, an HSA has a lot of advantages. If you’re enrolled in an HDHP, setting up a health savings account is definitely in your best interest. And if you don’t currently have HDHP coverage, it’s well worth considering as a future option. We gathered this guide to discuss HSA pros and cons. Contact us if you need more information about HSAs and a free 15-minute consultation!
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