In an effort to educate readers about the importance of healthcare coverage, especially during a global pandemic, we are creating a series about open enrollment for 2021. We will continue to share information about open enrollment and how it might affect this year, so please come back to read future posts.
Whether you became unemployed as a result of COVID-19’s economic disruptions, got a new job, or need to change your current plan for another reason, you should consider whether or not you need a health savings account (HSA). What is an HSA? While it’s not compatible with all health care plans, it is a unique account which allows you to set aside pre-tax funds to help cover out-of-pocket medical expenditures. It’s kind of like a flexible spending account (FSA), but has some key, and often misunderstood, differences.
With a still-raging global pandemic and open enrollment 2021 just around the corner, exploring your options for adequate health coverage should be a priority.
In case you’re wondering —“What is open enrollment, anyway?”— it’s a period of about five to six weeks in the fall when you may start, stop, or change your employer-sponsored or individual healthcare plan for the next calendar year. Open enrollment for the Health Insurance Marketplace, state exchanges, and individual plans is Nov. 1 through Dec. 15, 2020 for coverage beginning Jan. 1, 2021.
Your company may have its own open enrollment period, but it typically begins by November for the upcoming calendar year. This is when you’ll want to research your HSA options, learn how it could benefit you long-term, and enroll if it makes sense for your needs. We’ll discuss the main benefits of HSAs, eligibility requirements, and how they can be utilized for your long-term financial needs.
What is an HSA and how is it different from an FSA?
HSAs allow those who are eligible to put up to a certain amount of pre-tax income aside for heathcare needs. Limits on annual HSA contributions for coverage beginning in 2021 are $3,600 for individuals and $7,200 for family coverage. Even if your employer chips in with matching or supplementary funds, these limits are firm.
Unlike FSAs, which are typically “use it or lose it” accounts (with some limited exceptions), HSA funds may be carried forward indefinitely and don’t have balance limits. As an added bonus, these tax-free funds may earn interest.
Employers that offer healthcare plans with high-deductibles (often with relatively low monthly premiums) typically offer HSAs as well, but you may also enroll in a separate HSA if yours doesn’t. You decide how much to contribute each year, up to the maximum allowed and, if it’s through your workplace, a portion of your paycheck will be diverted to the HSA if you set up automatic payments.
You will receive either a checkbook or a debit card linked to this account, which you may use for qualified medical expenses your health insurance plan doesn’t cover, excluding monthly premiums. While the funds in an FSA go away at the end of the year if they aren’t spent, your HSA balance carries over each successive year and goes with you when you change jobs.
Qualified medical expenses, defined by the IRS include, but are not limited to:
- Birth control
- Chiropractic care
- Eye exams and contact lenses
- Feminine hygiene products
In addition to monthly premiums, you may not use your HSA to pay for anything your insurance company already covers. While this may seem obvious, it prevents fraudulent reimbursement claims for services already paid for by your insurer. While you may not contribute to an HSA once you turn 65 and become eligible for Medicare, you may contribute up to $1,000 in additional funds each year if you’re 55 or older in order to “catch up.” Here is a side-by-side comparison of FSAs and HSAs:
|Flexible Spending Account (FSA)||Health Savings Account
|Eligibility||Employer must set it up.||Must have a high-deductible health plan (HDHP), can’t be eligible for Medicare, and can’t be claimed as a dependent.|
|Annual contribution limits||· $2,750 for individuals
· $5,500 for families
|· $3,600 for individuals
· $7,200 for families
|Are contributions taxed?||No||No|
|Rolling over funds||Up to $500 may be rolled over each year, but only at the employer’s discretion. Otherwise, it’s “use it or lose it.”||Yes. Entire balance may be carried over to the next year.|
|Ownership||Employer||Individual. The HSA goes with you when you change jobs (but you don’t have to get it through your employer).|
|Changing contribution amounts||Must do so during open enrollment, unless you change employers or your financial situation changes.||You may do so at any time.|
|Withdrawal penalties||May not have access to funds for non-medical expenses, depending on your employer’s plan.||· Under age 65: 20% penalty tax for non-medical uses
· 65 and older: All withdrawals taxed as regular income
|Investment options||Maintained as cash by the employer.||May be invested in a mutual fund or exchange-traded fund (and any capital gains will be tax-free).|
Do you qualify for an HSA?
HSAs are available only to those enrolled in a high-deductible health insurance plan (HDHP), as defined by the IRS. HDHPs have a higher annual deductible than typical plans and a maximum limit on how much you may be required to pay for deductibles and other out-of-pocket expenses. For tax year 2020 (applicable to the upcoming open enrollment period), HSA-eligible HDHPs have:
- A minimum annual deductible of $1,400 for individuals, $2,800 for families
- Annual deductible and other out-of-pocket expenses totaling a maximum of $6,900 for individuals, $13,800 for families
Additionally, you are considered eligible for an HSA if you are not covered by another plan. There are some exceptions, including workers compensation, prescription plans, vision, dental, or coverage for a specific illness. Also, you may not be enrolled in Medicare or be claimed as a dependent on someone else’s prior year tax return. If your spouse qualifies for an HSA under a family health insurance policy, they must enroll in their own HSA — joint HSAs are not allowed.
If you’re already enrolled in an HSA, then you won’t have to do anything during open enrollment for it to continue into the following calendar year. If you’ve missed open enrollment, perhaps you started a new job and signed up for an HDHP, you may still enroll in an HSA at any time during the year.
Financial advantages of HSAs
While HSAs are primarily used for medical expenses not covered by your high-deductible health insurance plan, it helps to think of them as tools that could help you reach your long-term financial goals and limit medical debt. The flexibility and long-term viability of HSAs, including the fact that these funds immediately vest and don’t disappear at the end of the year, help make them very attractive for those who qualify. Some of the financial advantages of HSAs include:
Any money you put into your plan up to the annual limit is untaxed. If you’re enrolled in an HSA outside of employment, then your HSA contributions are tax-deductible. This means that if you put the maximum amount of $3,600 into your HSA and make $60,000 annually, you will be taxed as if you earn $56,400, lowering your tax burden and possibly putting you into a lower tax bracket.
Also, you will not be taxed as the account grows, nor will you pay taxes on any withdrawals for qualified medical expenditures. Keep in mind, however, that while you may use your HSA for non-medical purposes, you will incur a 20 percent penalty tax if you’re under 65. All HSA withdrawals after you’ve reached the age of 65 will be treated as taxable income, as with an IRA or 401(k), but you won’t incur an additional penalty.
You may keep your HSA in a cash account, but you could also choose to invest the capital. In fact, all HSAs have investment options that can help you grow your untaxed funds with the help of a positive market and you won’t have to claim capital gains or otherwise pay taxes on your investment gains. Keep in mind that markets and individual stocks do fluctuate, so your investment could lose value. However, it’s important to understand that HSAs have minimum cash requirements, and then anything above that required amount may be invested.
HSA-linked investment products are similar to IRAs and 401(k)s, with options such as mutual funds and exchange-traded funds. Even the more conservative funds with relatively low yields typically outperform prevailing interest rates. However, investment experts will tell you that past performance is no guarantee of future results.
You shouldn’t rely on an HSA for your retirement needs, but it could be a great way to add a little financial security for your golden years. Even if you use all of your HSA funds for medical expenses before reaching retirement age, you could still benefit. Enrolling in an HSA, considering you also have an HDHP, could be the difference-maker that keeps you out of crippling medical debt, especially during times of economic turmoil.
If you end up growing your HSA over the years or even decades, then you should have fortified your retirement nest egg. This means that younger, generally healthier people generally should consider an HSA even if they don’t need it right away. The dual trajectories of rapidly rising heathcare costs and the increased need for health interventions as we age means you’ll probably need more coverage and available funds as you near retirement.
Consider an HSA as part of your overall financial plan
Learning how to deal with debt, manage your finances, and plan for your future doesn’t need to be hard. But it’s important to consider the big picture even when you’re selecting health insurance coverage, as an HSA can play an important role in your financial security. Our simple-to-follow guide to help you find the tools you need to make the right choices that lead to a better financial future. Get started by downloading our How to Manage Debt guide.
- Health savings accounts: Is an HSA right for you? (Mayo Clinic)
- If You Have Lost Medical Insurance, You’re Not Alone (Freedom Debt Relief)
- Costs in Retirement Might Make You Reconsider an HSA (American Society of Pension Professionals and Actuaries)
- Why and How to Cut Health Care Costs (Freedom Debt Relief)
- Under CARES Act, tax-sheltered HSAs are even more useful now—how to make the most of them (MarketWatch)