If you haven’t already, you’ll probably hear from your employer soon about your company’s open enrollment period. That’s the time when you’ll select your employer-sponsored benefit plans, which can include health, vision, dental, disability, and life insurance. Most companies do this in the fall so your elections can take effect in the new calendar year. Open enrollment is generally the only time you can change your benefits unless you have a qualifying life event during the year.
Companies often update plans and premiums annually to keep up with industry trends and cost changes, so the coverage and premiums you have this year may not be the same next year. As your circumstances change, it’s especially important to examine your options and select those that best fit your current needs.
Of course, with the endless choices and confusing terminology, it’s tempting to just repeat what you did last year. But these decisions can have a significant financial impact, so it’s worthwhile to take some time and weigh your options carefully. And you might be missing out on a commonly underused option that could save you a significant amount of money in the long run: the health savings account (HSA).
What’s an HSA?
An HSA is a tax-sheltered savings account available to participants in high-deductible health plans (HDHPs) that can be used to pay for qualified medical expenses. HDHPs come with higher deductibles and out-of-pocket maximums than traditional health insurance plans. The rewards for taking on those higher costs are lower premiums and the opportunity to save on taxes by contributing to an HSA.
To boost your savings, many employers offer a match or make other contributions on your behalf if you elect the HSA option. HSA contributions can be saved in cash, but they can also be invested in securities, such as stock and bond funds, which can give your money the potential to grow.
Why use an HSA?
Once you learn how HSAs work, it’s easy to see why they’re so compelling. “When it comes to taxes, I like to describe them as a triple threat,” explains Taylor Turner, a senior financial advisor with Vanguard Personal Advisor Services®.
- Contributions are tax-deductible.
- Investment growth is tax-deferred.
- Qualified withdrawals are tax-free.
These are powerful benefits compared with other tax-advantaged or taxable account options(see Figure 1).
Figure 1. Taxes now, taxes later, taxes never
HSAs by the numbers: Costs and limits for 2021
Two critical numbers can help you determine whether an HDHP with an HSA is right for you—the deductible and the out-of-pocket maximum. The federal government regulates these costs as well as the contribution limits for HSAs. Figure 2 shows the minimum deductibles and maximum out-of-pocket costs for 2021. Figure 3 displays the maximum amounts participants can contribute to their accounts in 2021.
Figure 2. High-deductible health plans must meet certain criteria
Figure 3. Maximum HSA contributions for 2021
HSAs provide flexibility
Unlike other health care accounts, such as flexible spending accounts (FSAs) and health reimbursement accounts (HRAs), there’s no “use it or lose it” restriction on HSAs. They allow you to roll over all your savings from year to year. If you leave your employer, you take your HSA with you. It’s yours forever—which means you can potentially accumulate a sizable long-term balance to pay for health care expenses in the future.
Withdrawals must be used for qualified medical expenses, such as doctor visits, medications, and other expenses that can be deducted on a tax return, but the timing of withdrawals is entirely up to you. You can make a withdrawal at any point in the future for any qualifying expense incurred since you opened the account.
For example, let’s say you pay $2,000 out of pocket this year for your daughter’s braces. Rather than use your HSA funds now to cover that expense, you save the receipt and leave the money in your account. Then, in 10 years when it’s time to pay for her college tuition, not only can you use that receipt to withdraw the funds from your HSA—tax-free—but your account has increased in value thanks to the power of compounding.
It’s important to be aware that if you take a withdrawal without a qualified medical expense, the amount will be subject to income taxes and, if you’re under age 65, a 20% penalty. But HSAs can also be used to pay Medicare premiums (except for Medigap premiums) or to buy long-term care insurance. With so much flexibility, the risk of incurring taxes or penalties is low.
Making an HSA work for you
If you’re relativity healthy and have low annual health care expenses, consider an HDHP with an HSA to lower your insurance premiums today, and set aside those savings for future health care expenses. If you can, try to max out your HSA contribution each year. Think of your HSA assets the way you think of your retirement account—invest it for the long term to allow returns to compound as long as possible, and pay near-term expenses out-of-pocket. Just be sure to keep your receipts for future qualified withdrawals.
Make the most of open enrollment
During open enrollment, take time to consider your options rather than defaulting to what you elected last year. You can find the plan that’s best for you by comparing premiums, deductibles, out-of-pocket maximums, and tax costs. Don’t hesitate to ask for help from your company’s benefits department, or consult with a financial advisor about your individual situation. If your expected health care costs are low and you’d like to maximize your tax savings, an HSA in conjunction with an HDHP might be right for you.