How a health savings account (HSA) works

Health coverage plan combines tax-advantaged personal savings with high-deductible health insurance policy (HDHP)

  • August 17, 2017

Would you like the ability to pay for medical expenses with pre-tax money? What about the option to build retirement savings that can be used at any time – without taxes or penalties – to pay medical expenses that arise along the way? Do you prefer coverage that comes with a higher deductible and lower premiums?

A health savings account (HSA) could be just what the doctor ordered. Used wisely, this innovative approach to health coverage may provide major advantages that could keep both your personal and financial life healthy.

A health savings account is a tax-advantaged personal savings account that works in combination with an HSA-qualified high-deductible health insurance policy (HDHP) to provide both an investment and health coverage. The savings account provides the funds you use to pay medical expenses or  – if you don’t need to use it – is an interest-bearing nest egg that grows until you retire. The HDHP, meanwhile, is your safety net should you need catastrophic coverage for major medical expenses.

How an HSA works

Opening an HSA allows you to pay lower federal income taxes by making tax-free deposits into your account each year. Most states (all but California, Alabama, and New Jersey) also offer tax breaks on funds deposited in these accounts. The 2017 contribution limit is $3,400 if you have individual coverage under your HDHP, and $6,750 if you have family HDHP coverage. For 2018, these amounts will grow to $3,450 if you have individual coverage, and $6,900 if you have family coverage. You can deduct your contributions even if you take the standard deduction and don’t itemize. If you’re 55 or older, you can contribute an extra $1,000 a year.

The money you deposit into your HSA is yours to withdraw at any time to pay for medical expenses that aren’t paid by your high-deductible individual health insurance policy. HSAs are considered part of consumer-driven health care (CDHC), meaning that you control the plan, deciding how to spend and invest those dollars.

Expenses may include deductibles, copayments, coinsurance, vision and dental care, and other out-of-pocket medical costs. And the range of services that qualify is broad: You can use your HSA to pay for acupuncture, chiropractor services, or even traditional Chinese medicine (everything you can use it for is listed in IRS Publication 502). Since 2011, however, individuals have not been able to use tax-advantaged money from an HSA for over-the-counter drugs that are not prescribed by a doctor.

You can also use the account to pay for the medical expenses of a spouse or other family members (dependent children or qualifying relatives), even if they aren’t covered by your HDHP.

If you’re fortunate enough to not need to withdraw from the account to pay for medical expenses, your funds roll over from year to year and your account continues to grow (including investment returns or interest, depending on where you deposit your HSA funds).

When you reach age 65, you’re allowed to draw from any unspent HSA funds. You can still spend the funds tax-free for medical expenses, or you can withdraw them without penalty to use them for non-medical expenses (though you will pay income tax on the withdrawals if you don’t use them for medical purposes, just as you would if the funds were in a traditional IRA). If you withdraw the funds prior to age 65 for purposes other than paying medical expenses, you’ll owe a 20 percent penalty on the withdrawal.

Sounds too good to be true? Well, remember that you’re paying a lower premium for your insurance coverage because it’s a high-deductible plan that doesn’t cover anything other than preventive care before the deductible. If you need to see the doctor, you’ll pay the entire bill (reduced according to the negotiated rates your health plan has with the doctor) if you haven’t yet met your deductible.

2018: Higher contribution limits, deductibles, and out-of-pocket maximums

HSA-qualified plans have deductibles starting at $1,300 for singles and $2,600 for families in 2017 (unchanged from 2015 and 2016), although the minimum deductible is slightly higher for 2018, at $1,350 for an individual and $2,700 for a family.

But HSA-qualified plans have also always had limits on how high the maximum out-of-pocket can be — unlike the rest of the market, which didn’t have limitations like that until 2014 when the bulk of the ACA was implemented. In 2017, as was the case in 2015 and 2016, the maximum out-of-pocket limits for HSA qualified plans is lower than the maximum out-of-pocket established for all plans under the ACA. For HSA-qualified plans in 2017, it’s $6,550 for individuals and $13,100 for families, as opposed to the general market rules that limit out-of-pocket spending to $7,150 for individuals and $14,300 for families.

And for 2018, the difference becomes even more pronounced: The maximum out-of-pocket for HSA-qualified plans is $6,650 for individual coverage and $13,300 for family coverage in 2018, while the overall maximum out-of-pocket that applies to non-HSA-qualified plans is $7,350 for individual coverage and $14,700 for family coverage.

Health savings accounts get mixed reviews

The country is largely split over the question of whether health savings accounts are a wise coverage solution on a large scale – and whether HSAs help or hurt the nation’s health care system.

Proponents of HSAs argue that people tend to be more careful with their own health care costs when they’re paying part of the bills themselves. So instead of going to a doctor for every cough, cut or cramp, HSA users would have an incentive to be less wasteful with their health care spending, and maybe even take the time to shop around.

They say that the cumulative effect will be a nation of health consumers whose behavior would lower health care costs, while injecting price and quality competition into the medical marketplace. And tax advantages, they say, could lure the uninsured into lower-cost, high-deductible plans, reducing the ranks of the uninsured and possibly even nudging them into healthier lifestyles.

Critics of HSAs argue that health savings accounts benefit the young and healthy, while those with regular medical problems or who are older may end up paying more because they tend to drain their savings with more frequent up-front medical expenses. Critics also argue that the accounts destabilize the health insurance marketplace by shifting healthy insureds to high deductible plans, thus driving up premiums for those remaining on more robust plans.

Another argument is that the tax-advantaged option constitutes a tax shelter for the rich, and that low-income families don’t earn enough to benefit from the tax breaks. Further, skeptics warn that many people with HSA plans – and especially the poor – might be reluctant to spend money from their savings account, even on necessary healthcare expenses. Although a reduction in spending on unnecessary care would be beneficial, it’s often hard for a consumer to know what care is necessary and what’s unnecessary, and skimping on the former could lead to higher-cost problems later.

But it’s worth noting that the ACA requires all plans – including HSA-qualified plans – to cover preventive care with no cost-sharing.  So although HSA-qualified plans have historically required enrollees to meet the deductible before claims are covered, all current HSA-qualified plans cover the full range of recommended preventive care before the deductible.

Accounts are becoming mainstream

According to the 2015 census, enrollment in HSA-qualified HDHPs has soared to 19.7 million people (more than three-quarters had HDHP coverage provided by a large employer). By 2016, enrollment had grown further, to 20.2 million. This is up from 10 million consumers in 2010 and according to data from America’s Health Insurance Plans (AHIP), enrollment has been growing at a rate of about 15 percent per year since 2011. AHIP’s data indicates that 8 million individuals were enrolled in HSAs in 2009 and just 3.2 million in 2006. Not all of those enrollees contribute funds to an HSA, but they’re eligible to do so if they want.

Many businesses, large and small, offer these HDHP policies to their employees, but you can also purchase them on your own through the exchange in your state or directly from a health insurance carrier. introduced optional standardized plans for 2017, and for 2018, they’re expanding the standardized plan selection to include an HSA-qualified HDHP.

Health insurance companies will generally recommend a bank that insureds can use to establish an HSA once they’re enrolled in an HDHP, but enrollees are free to select any HSA custodian they like. A long list of banks, credit unions, and brokerage firms offer accounts for saving and growing HSA funds over time, so shop around before you select an HSA custodian. The saving accounts include a dizzying array of options. And brokerages offer countless stocks, bonds and funds to invest in with low trading fees, while others may have limited choices, are more expensive, and have hidden fees.

HSAs play a bigger role under GOP health care reforms, but nothing has changed yet

Republicans in Congress have spent much of 2017 focused on their efforts to repeal and replace the ACA, but their efforts stalled in late July when Senate Republicans failed to pass three different versions of the ACA repeal bill that the House had passed in May.

There is little doubt that Congressional Republicans will continue to try to repeal and replace the ACA if they’re able to muster enough votes to do so, but for the time being, the ACA remains fully intact.

All of the bills the GOP considered included reforming HSAs to allow for larger contributions, lower penalties, and more latitude in terms of use of HSA funds. Even the Senate’s “skinny” repeal bill —which was only eight pages long and was a last-ditch effort to pass something that could lead to a conference committee with House Republicans — included HSA reform.

Some GOP proposals call for partial government funding of HSAs, others would allow people to contribute more to their HSA (which critics note is likely to be much more beneficial for the wealthy than for the poor), and would allow more people to contribute to HSAs. Former Georgia Representative Tom Price, who now leads HHS, introduced legislation in 2015 to replace the ACA, and it relies heavily on HSAs.

With the current political leadership, HSAs are certainly here to stay. And there’s a good chance that they could be enhanced in some way under the Trump Administration. But for the time being, nothing has changed. Republican lawmakers have tried to increase contribution limits for HSAs, reduce the penalty for under-65 withdrawals for non-medical expenses, allow HSA funds to be used for over-the-counter medications, and allow HSA funds to be used to pay health insurance premiums (currently that only works for COBRA premiums, Medicare premiums, long-term care premiums, or health insurance premiums paid while the person is receiving unemployment benefits). But as of August 2017, none of the measures have passed, and the rules governing HSAs remain unchanged.