October 28, 2022

Health Savings Accounts (HSA): A Simple Guide (2023)

Contents

A Health Savings Account (“HSA”) is a tax-advantaged savings account that allows eligible taxpayers to pay for qualified medical expenses. It’s like a savings account, only better: contributions are tax deductible and earnings are tax-free (as long as you pay for medical expenses). This article will cover everything you should know to get started: from setup, to contributing, to taking distributions.

What is an HSA?

An HSA is like the savings account you might already have with your bank. You make contributions into the account and earn interest on the contributions. 

Unlike a regular savings account, an HSA is tax-advantaged. This means that HSA contributions are tax-deductible and earnings are tax-free. 

The catch is that you must use money in your HSA for qualified medical expenses—including insurance deductibles, copays and coinsurance (but not premiums).

Tax benefits of an HSA

HSA contributions benefit from a triple tax advantage: HSA contributions are tax-deductible, investment earnings within the HSA accumulate tax-free, and HSA distributions aren’t taxable if they’re used to pay for qualified medical expenses.

HSA contributions are made “pre-tax,” which means you deduct contributions from taxable income when filing your tax return. By making HSA contributions you decrease the amount of tax you’ll pay for the year in which you make the contribution. 

For example, if you contributed $1,000 to an HSA last year, you’d get a deduction of $1,000. The deduction would result in a lower tax bill when filing your tax return this year.

Contributions to your HSA can be invested in stocks, bonds or other securities as well as cash equivalents like certificates of deposits (CDs), treasury bills (T-bills), money market accounts and fixed annuities. 

Investment earnings accumulate tax-free. You don’t pay tax on the income generated by these investments. For example, if you earned $100 in interest through an investment in your HSA last year, this income would not be taxed when filing your tax return this year.

At some point you’ll withdraw your contributions and investment earnings from the HSA. When you do, the distribution is tax-free to the extent that it pays for qualified medical expenses.

Who can contribute to an HSA?

To be eligible for an HSA, you must:

  • Be covered by a high-deductible health plan (HDHP). An HDHP is a health insurance policy that has an annual deductible of at least $1,400 ($2,800 for family coverage) and a maximum out-of-pocket limit of $7,050 ($14,100 for family coverage).
  • Not be enrolled in Medicare.
  • Not be claimed as a dependent on another person's tax return.

It’s possible that you were eligible for part of the year and ineligible for another part of the year. If this applies to you, you may be eligible to contribute to an HSA under the IRS’ “last-month rule.”

Under the “last-month rule,” you’re allowed to make HSA contributions if you meet each of the eligibility rules listed above on the first day of the last month of your tax year (i.e. December 1st).

How to contribute to a Health Savings Account?

You can contribute to an HSA through your employer or directly to an account you open through a financial institution, such as your bank.

If your employer offers a health savings account, and you’re eligible, you’ll make contributions through pre-tax deductions withheld from your paycheck. Your employer then deposits the withholdings into the HSA. 

Your employer may also contribute matching contributions to the HSA, if this is a benefit they offer. Some employers do but they’re not required to do so.

If you’re self-employed or your employer doesn’t offer an HSA, you can open an HSA at a financial institution of your choice. You’d then make contributions to your HSA by transferring funds from your bank account into the HSA.

Family members can contribute to your HSA too. You’d still be eligible for the deduction.

What are the contribution limits for an HSA?

The 2022 HSA contribution limits are:

  • Self-only health coverage: $3,650 per year;
  • Family coverage: $7,300 per year.

If you’re 55 or older at the end of the tax year, you can make an additional $1,000 in catch-up contributions.

Employer contributions count toward the annual contribution limit. So, if your employer contributed $500 in addition to the amount you contributed from payroll deductions, your total contributions can’t exceed $3,150 for the year, assuming you’re single.

HSA contributions for a particular tax year must be made on or before April 15th of the following year. For example, if it’s January and you’d like to maximize your HSA contributions for last year, you’d have until April 15th of this year to make your HSA contribution.

How to invest HSA contributions

HSA contributions can be invested in a variety of ways. Investment options include: mutual funds, stocks, bonds and other securities. You can also invest in a simple money market account or certificate of deposit (“CD”). 

Your HSA administrator will provide information about the investment options they allow. 

Once invested, all investment income earned from your contributions will accumulate within the HSA tax-free. Dividend income earned from a stock in your HSA last year, for example, wouldn’t be reportable as income on your tax return.

How to withdraw from an HSA

The exact steps for withdrawing funds depends on your HSA administrator. 

Some administrators issue a debit card with which you can make health-related purchases directly from your HSA. You might also submit receipts to the administrator’s online portal to request a reimbursement. The administrator then mails you a check or transfers the reimbursement directly to your bank account.

You can withdraw money from your HSA at any time to pay for qualified medical expenses. Withdrawals are tax-free to the extent they paid for healthcare expenses. 

You can also withdraw from your HSA to pay for expenses not related to healthcare. However, these withdrawals will be taxable and subject to a 20% penalty.

You should save receipts to document your medical expenses. In the event of an audit, the IRS will confirm that the total amount distributed from your HSA doesn’t exceed the total amount you spent on qualified medical expenses. Keeping receipts helps substantiate this claim.

What can an HSA be used for?

The IRS publishes an exhaustive list of HSA-eligible purchases. See “What Medical Expenses Are Includible?” in Pub. 502

In general, you can use HSA funds to purchase over-the-counter and prescription medications. You can also use your HSA to pay for dental and vision care services.

The qualifying purchase doesn’t necessarily have to have been made by you. For example, if your spouse or dependent made a qualifying purchase, that purchase would be HSA-eligible.

Insurance deductibles, copays and coinsurance are HSA-eligible expenses. However, health insurance premiums aren’t HSA-eligible expenses, unless the premiums are for long-term care insurance, COBRA, coverage while receiving unemployment compensation, or Medicare (if you’re 65 or older).

A qualified medical expense must have been incurred after your HSA was established. In other words, you must have opened your HSA before you paid for a medical expense.

Health Savings Account tax forms

If you contributed to an HSA, you’d report the contribution on Form 8889 of your annual tax return to claim the deduction. You can confirm the amount you contributed by reviewing the HSA account statements (the December statement is usually the best place to look).

You’ll probably receive Form 5498-SA from the HSA administrator in June. The HSA administrator sends this form to you and the IRS to report contributions you made to the IRS. The amounts on this form should line up with the contributions you reported on Form 8889 of your tax return. 

Form 5498-SA and Form 8889 may not agree if you made contributions in the current year for the previous year. You should review to confirm that this is the case.

If you took a distribution from an HSA, the HSA administrator would send you Form 1099-SA at year-end. This form, like other 1099s you might receive, informs the IRS that you received taxable payments from the HSA administrator.

Whether or not you’re taxed on the distribution depends on how much you spent on qualified medical expenses during the year. If your total qualified medical expenses are greater than the amount on Form 1099-SA, the distribution is tax-free. If the total is less than the amount on Form 1099-SA, the distribution is taxable.

Regardless of whether the distribution is taxable, you’d first transfer the distribution amount on Form 1099-SA to Form 8889 of your tax return. You’d then input your total qualified medical expenses for the year to Form 8889. If there’s a taxable amount (because your expenses are less than the HSA distribution), you’d then transfer this amount to Schedule 1 of your tax return.

“Do HSA contributions rollover from the previous year?”

If you have an HSA and your account balance is greater than the minimum required for health care expenses, you can rollover funds from a previous year. You can also rollover funds to another HSA account (or multiple accounts), or to a traditional or Roth IRA. If you are no longer eligible for an HSA because of changes in your employment or family circumstances, your employer may allow you to withdraw funds from the plan as long as they are used within 120 days before coverage ceases.

If you need health care but don't have enough money saved up in your account, there's good news: some plans allow members with low balances to pay their deductible out-of-pocket rather than having their insurance provider cover it first.

"FSAs vs HSAs - what are the differences?"

Health savings accounts (HSAs) are tax-advantaged accounts that allow you to pay for current and future medical expenses. They're similar to flexible spending accounts (FSAs), which are also tax-advantaged, but HSAs are generally more advantageous.

Here's a look at the key differences between the two:

Flexible Spending Accounts: 

Eligibility

  • Your employer must open the FSA.
  • You’re not required to be enrolled in a high-deductible health plan (“HDHP”).

Tax Benefits: 

  • Your employer deducts pre-tax contributions from your paycheck.
  • You can use contributions to pay for qualified medical expenses.

Contribution Limits (2022): 

  • Each taxpayer may contribute $2,850 ($5,000 per family for dependent-care FSAs)

Rollover: 

  • Contributions not used at year-end are forfeited, unless your employer offers a grace period.

Investment Options: 

  • Contributions can’t be invested.

Employer Matches:

  • Your employer may also make tax-free contributions.

Health Savings Accounts: 

Eligibility

  • You or your employer may open the FSA.
  • You must be enrolled in a high-deductible health plan (“HDHP”).

Tax Benefits: 

  • Your employer deducts pre-tax contributions from your paycheck or you make contributions directly to the HSA.
  • You can use contributions to pay for qualified medical expenses.

Contribution Limits (2022): 

  • Each taxpayer may contribute $3,650 ($7,300 for family coverage)
  • An additional $1,000 contribution is allowed if the taxpayer is over 55 years old.

Rollover: 

  • Undistributed contributions and earnings rollover to the following year.

Investment Options: 

  • Contributions can be invested in stocks, bonds, and interest-bearing securities.

Employer Matches:

  • Your employer may also make tax-free contributions.

“Are HSA distributions taxable if I’m no longer eligible to make contributions?”

No, if you’re no longer eligible to contribute to your HSA, you can still take non-taxable distributions to the extent the distributions cover qualified medical expenses.

Conclusion

HSAs are a great way to save for healthcare expenses and avoid taxes. If you’ve got a large medical event on the horizon, consider funding an HSA to pre-fund the associated expenses, assuming you’re HSA-eligible.

This content is for informational purposes only and does not constitute legal, business, or tax advice. You should consult your own attorney, business advisor, or tax advisor regarding matters mentioned in this post. We take no responsibility for actions taken based on the information provided.

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