Each year, the average American spends twice as much on health care as they do on groceries. That's just shy of the average mortgage payment for a 30-year loan.
According to the Centers for Medicare and Medicaid Services (CMS), Americans spent $11,582 per person on health care expenses in 2019. That’s almost $1,000 per month on health insurance premiums and out-of-pocket costs. You won’t get relief anytime soon: CMS projects national health spending to grow at an average annual rate of 5.4 percent through 2028.
Unlike groceries and loan payments, health care can be difficult to budget for. You don’t always know when you’ll need health care, and you often don’t know how much it will cost you out-of-pocket.
This is part of the reason why medical debt is such a problem in the U.S. A recent LendingTree survey showed that 37 percent of respondents currently have medical debt. The average amount of that debt was between $5,000 and $10,000. Medical debt is one of the leading causes of bankruptcy filings.
One way to save for health care costs, save on your tax bill, and better budget for medical expenses is through a health savings account (HSA).
An HSA is like a personal savings account, only the money is designed to cover health care costs. You and/or your employer can deposit money into the account. Then, when you have an out-of-pocket medical expense, you can use the funds in your HSA to cover all or part of the bill.
Not everybody is eligible to use an HSA, which is governed by the Internal Revenue Service. That’s because there are tax advantages to using an HSA for your health care expenses.
To qualify for an HSA, you must:
- Be covered by a high-deductible health insurance plan (HDHP), which includes catastrophic health plans.
- Not have other health coverage.
- Not be enrolled in Medicare.
- Not be claimed as a dependent on someone else’s tax return.
You can only use an HSA if you have a high-deductible health plan. This type of plan charges the lowest amount of premium compared to other types of health insurance. In exchange for saving on premium, the deductible you must meet before the policy covers expenses is much higher than other plans.
For 2021, the IRS minimum deductible to qualify as a high-deductible health plan is $1,400 for individuals and $2,800 for family coverage. The maximum deductible is $7,000 for individuals and $14,000 for families.
The IRS also places limits on how much can be contributed to your account each year. The annual contributions limits for 2021 are $3,600 for individuals and $7,200 for families. If you are 55 or older, you can contribute an additional $1,000.
If you’re covered by an employer-sponsored HDHP, you can contribute to your HSA through payroll deduction. You also have the option of starting an HSA on your own through a bank or other financial institution, which is a good option if you are self-employed.
If you use payroll deduction, your employer can make contributions to your HSA. If you have an individual HSA, family members or other people can contribute to your account. Keep in mind that the total amount contributed by you and by others on your behalf, when combined, cannot exceed the IRS contribution limits. For example, if your employer contributes $600 a year to your individual HSA, you can only contribute $3,000 to avoid exceeding the $3,600 annual IRS limit.
Because HSAs are linked to a bank account, many of them today issue users a debit card that they can use at the time of treatment or when they pay a bill electronically. Some HSAs, however, may require you to request a distribution reimbursement for expenses you’ve already paid for.
You can only use HSA money for qualified medical expenses. These include out-of-pocket expenses for most medical, dental, and vision treatment, for you and your dependents. You can find a complete list of qualified medical expenses in IRS Publication 502.
Expenses that you typically can’t use an HSA to pay for include:
- Insurance premiums for which you already receive tax credits. If you’re paying your health insurance premiums with pre-tax dollars, as is typically the case, you cannot use your HSA to pay those premiums.
- Cosmetic surgery
- Drugs, such as aspirin, that do not require a prescription
- Medicine purchase in other countries
- Nutritional supplements
- Health club memberships
- Weight-loss programs, unless it’s recommended by a physician for the treatment of a specific condition, such as heart disease
- Any expenses you incurred before you established your HSA
- Expenses that are not in any way related to receiving medical care
If you receive distributions for non-covered expenses, the amount you withdraw will be subject to income tax and may be subject to an additional 20 percent tax penalty.
You are not required to use any of the money in your HSA at any time. There is no limit as to how much you can save over several years. If you want to pay for today’s out-of-pocket costs through other means and save your HSA for future medical needs, you can do that.
Contributing to an HSA can help you reduce your taxable income. If you use payroll deduction, HSA deposits are deducted before your income taxes are. For example, if you earn $75,000 a year and contribute $5,000 to an HSA, your taxable income would be $70,000. Contributions also reduce state income taxes in most states.
If you contribute money to your own account using after-tax dollars, you can deduct the amount from your gross income on your tax return.
Withdrawing money from an HSA does not affect your taxes, so long as you use the money for qualified medical expenses. HSA withdrawals are not treated as income. In addition, interest earned in an HSA, though minimal, is not considered taxable income.
You may also be familiar with or have heard about the flexible spending account (FSA). Though there are similarities, an FSA is not the same as an HSA. In most cases you have to choose one or the other; you can’t have one of each.
Whereas HSAs can only be used with high-deductible plans, FSAs can be used for standard health plans.
FSAs also allow you to access funds that are not yet deposited into your account. For example, if you budget $2,000 for your FSA for the year, your employer will deduct an amount per month or per pay period that totals $2,000. But the entire $2,000 will be available to you at the beginning of the plan period, which is usually January 1.
HSAs, on the other hand, require the money to be in the account before it’s used. So if you budget $2,000 a year for your HSA, you may only have $167 to spend on medical expenses at the end of the first month of the year. This can be challenging because, with an HDHP, you’ll be responsible for 100 percent of most procedures until you meet the deductible.
One advantage of an HSA is that you don’t have to spend your full amount each year. Whatever you have in the account at the end of the plan year will rollover. Plus, HSAs are portable, meaning you can take the account with you if you leave your employer.
FSAs only allow users to rollover $500 per year. Any unspent funds above that limit are forfeited by the account holder. Also, you can’t take money from an employer-sponsored FSA if you quit or change jobs.
[ Related read: HSA vs. FSA: Which is better for your healthcare needs? ]
Joel Palmer is a freelance writer and personal finance expert who focuses on the mortgage, insurance, financial services, and technology industries. He spent the first 10 years of his career as a business and financial reporter.
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