In previous posts of the Personal Finance Basics series, we covered 401(k)s and the traditional IRA.
As we learned in those posts, these accounts are awesome because they lower your taxable income and thus the amount of taxes you pay in that year.
In this post, I’ll cover the Health Savings Account (commonly referred to as an HSA) which is yet another account you can use to save on taxes.
Health insurance basics
When it comes to health insurance, there are essentially two choices:
- A “standard” plan
- A high-deductible health plan (HDHP)
Both of these plans have a:
- This is the fixed monthly fee the health insurance provider2 charges you.
- This is the amount you pay before your insurance starts to pay.
- For HDHPs, this number is defined by the IRS. In 20223, the minimum deductible is $1,400 for individuals and $2,800 for families.
- With a $1,000 deductible, for example, you’d pay the first $1,000 in medical costs out of your own pocket. After that, the insurance would cover part of the costs.
- Out-of-pocket maximum4
- This is the most you’ll pay for health care in a given year.
- The premium doesn’t count toward the out-of-pocket maximum.
- For HDHPs, this maximum is defined by the IRS. In 2022, it’s $7,050 for individuals and $14,100 for families.
- With an out-of-pocket maximum of $2,500, for example, the insurance would take care of all medical costs after you’ve paid $2,500.
- You pay a fee every month. This is your premium.
- You pay for all medical expenses until you meet your deductible, at which point your insurance starts to pitch in.
- The max you’ll pay in a year is your out-of-pocket maximum.
Standard vs HSA
The main differences between a “standard” plan and an HDHP are that an HDHP:
- Has a higher deductible5 and out-of-pocket maximum.
- Has a lower monthly premium.
- Can be paired with a Health Savings Account (HSA).
- It isn’t possible to have an HSA with a “standard” plan.
- An HSA can be big benefit and we’ll discuss it more in the next section.
The nice thing is that preventive care is generally completely free in both the standard plan and the HDHP.
Preventive care includes annual physical examinations (including doctor ordered blood tests), immunizations, mammograms, pap smears, STD screenings, colonoscopies, and other exams and preventive measures of the sort.
The cost for pharmacy prescriptions is also generally very similar between the standard plan and the HDHP. Birth control is typically free in both plans.
Health Savings Account
An HSA is the big benefit of a high-deductible health plan.
An HSA is a savings account meant to cover medical expenses and is fairly similar to the IRA and 401k.
How is an HSA similar to a 401k and an IRA?
- Like the 401k and IRA, an HSA is tax-advantaged—every dollar you put into it helps lower your taxes.
- Like with the 401k match, an HSA might get you some free money from your employer.
- For example, your employer might put $500 into your HSA every year.
- Like the 401k and IRA, HSA funds can be invested and any investment gains are tax-free.
- Like the 401k and IRA, an HSA has an annual contribution limit.
- Like the 401k and IRA, an HSA has an early withdrawal penalty if withdrawing before 65.
- This penalty is 20%, unlike the IRA and 401k which have a withdrawal age of 59½ and a penalty of 10%.
But an HSA is better than an IRA or a 401k in some regards because:
- The money in an HSA can be withdrawn tax-free for ANY medical expense at ANY time.
- This is a unique benefit of HSAs over the 401k and IRA which don’t provide this mechanism to make tax-free, penalty-free withdrawals before retirement age.
- The HSA is famous for its triple tax advantage: tax-free contributions, tax-free growth, and tax-free withdrawals.
- When you turn 65, you can use the money for ANY expense, not just medical.
- This effectively turns your HSA into an IRA once you turn 65—with the added benefit of tax-free withdrawals for medical expenses.
- Just like with the IRA, you’ll pay income tax when withdrawing money for non-medical expenses. But no penalty.
- It has no income limit—if you have an HDHP, you can have an HSA.
Should I have a Health Savings Account?
You should absolutely fund your 401k and your IRA (either traditional or Roth depending on your income) every year. To the max, if possible.
The choice between an HDHP with an HSA and a standard plan isn’t as clear.
If you’re relatively young and healthy and don’t often need to see a doctor, the HDHP plus HSA combination is a great choice.
It allows you to lower your taxes and have another source of money that can be invested to grow tax-free. The out-of-pocket maximum, meanwhile, protects you from any medical catastrophes.
But an HDHP plus HSA isn’t always the best option.
If you have a medical condition, such as diabetes, or are planning on getting pregnant or having major surgery done, the standard plan might be a better option.
It’s good to note that you can switch your health care plan every year during the annual enrollment period.
On most years you might decide to have an HDHP with an HSA, but on some years you might opt for the standard plan depending on what’s going on in your life.
For what it’s worth, I’m in my late twenties and I’ve had an HDHP with an HSA ever since I graduated from college and started paying for my own health insurance.
I’ve only had to go to the doctor for annual checkups and by having an HSA I’ve been able to:
- Get free money from my employer
- Save on taxes
- Amass a nice little sum that has grown through the years because of investment gains
There you have it. You’re now knowledgeable about HSAs, yet another tax-advantaged account.
Become comfortable with the HSA because it’s a valuable tool in your personal finance toolbelt.
Lower taxes, free money, less restrictions on withdrawals… basically an IRA on steroids. What more could you want?
I hope this was helpful. Shoot me an email if you have any questions.
And if you’re looking to learn more, you can find the whole Personal Finance Basics Series here.
Video for this post
If you prefer watching to reading, here’s an easy-to-follow video I made with all this info:
Slides for this post
And here are the slides I used for the video.
The HealthCare.gov site has a great glossary of all these terms. See premium, deductible, out-of-pocket maximum, high deductible health plan (HDHP), and health savings account (HSA). ↩
Examples of health insurance providers include Aetna, UnitedHealthcare, Anthem, Humana, Blue Cross Blue Shield, Cigna, and Kaiser, among others. ↩
See here for the 2023 deductible ($1,500 for individuals, $3,000 for families) and out-of-pocket maximum ($7,500 for individuals, $15,000 for families). ↩
The deductible and out-of-pocket maximum reset every year when you renew or change your health insurance plan. ↩
Hence the name, high deductible health plan 😄 ↩
See here for the 2023 contribution limits ($3,850 for individuals, $7,750 for families). ↩
Due to inflation, this contribution limit (along with the deductible and out-of-pocket maximum) generally increases from year to year. ↩