Dispelling Misconceptions About Health Savings Accounts (HSAs)
- HSAs are gaining more attention with the current spotlight on health care reform and retirement security.
- HSAs offer tax advantages: tax-free contributions, tax-free interest, tax-free distributions for qualified medical expenses.
- Erroneous beliefs keep these savings vehicles from wider adoption.
- Businesses must take care to educate employees about these plans.
Common misconceptions about the benefits of HSAs
With health care reform and retirement security leading current headlines, the importance of health savings accounts (HSAs) has gained simultaneous momentum. Congressional Republicans include expanded use of HSAs in their efforts to repeal and replace the Affordable Care Act, with good reason: Along with increased consumer control over health care spending, HSAs offer major tax advantages.
However, employers and employees alike have many misconceptions about HSAs. Too often, people think that HSAs:
- Are best suited for older people;
- Are exclusively for medical costs;
- Are the same as flexible spending accounts (FSAs); and
- Cannot be invested.
Such erroneous beliefs keep these savings vehicles from wider adoption.
How an HSA works
Created by Congress in 2003, the HSA combines a high-deductible health insurance plan with a tax-advantaged savings account. It resembles a personal savings account, but the funds go to pay health care costs. The account holder owns the money and the interest it earns. She or he controls how HSA money is spent. Contributions are tax-free, earnings accumulate tax-free, and distributions are tax-free for qualified medical expenses.
Money in an HSA:
- Can be used to pay the health insurance policy deductible and qualified medical expenses, including costs for dental and vision services, which are often not covered by health plans.
- Is taxed if withdrawn for nonqualified expenses. These funds are taxed at the account holder’s income tax rate, plus 20 percent if the individual is younger than 65.
- Earns interest, usually on a tiered rate schedule, depending on the deposit amount. Interest earnings are not taxed.
Nationwide, HSA enrollment is growing, but there is still plenty of room for expansion. A 2016 survey by America’s Health Insurance Plans of U.S. health insurance companies offering HSA/high-deductible health plans shows that enrollment totaled approximately 20.2 million in January 2016, up from 19.7 million in 2015.
Let’s look at the misconceptions that keep many employers and employees from taking advantage of HSAs.
Misconception 1: HSAs are best suited for older people
On the contrary, HSAs benefit all age groups, and enrollment is relatively equal across age groups. Among 40 insurers, the AHIP survey found that:
- 21 percent are younger than 18;
- 11 percent are age 18-24;
- 30 percent are age 25-44;
- 35 percent are 45-64; and
- 3 percent are 65 and older.
Applied with knowledge and planning, HSAs can provide a smart way to save for health care expenses.
Misconception 2: HSAs are exclusively for medical costs
This is true for those younger than age 65, but those at or above traditional retirement age can withdraw their HSA dollars for any reason. These distributions are taxable at ordinary income rates, as with individual retirement account (IRA) or 401(k) distributions.
Misconception 3: HSAs are the same as flexible spending accounts (FSAs)
False. HSA plans are designed to encourage health care consumerism, while FSAs focus on using pretax dollars to cover expenses. FSAs let people use pre-tax dollars to cover eligible health care expenses for themselves and dependents. FSAs generally have an annual “use-it-or-lose-it” mandate, while HSAs do not.
Misconception 4: HSAs cannot be invested
False. In addition to the triple tax advantage — contributions are tax-deductible, interest earned is tax-free, and you can make tax-free withdrawals to cover qualified medical expenses — the balance in an HSA can grow via investing, similar to an IRA. Like IRAs, HSA balances can be invested in mutual funds, stocks, and bonds.
HSAs can be part of long-term savings strategy
Because of HSAs’ structure and requirements for use, businesses must take care to educate employees about these plans, ideally during open enrollment for workplace benefits. For instance, if you choose to match a portion of workers’ contributions, communicate this incentive as a way to encourage participation. With the right HSA in place, employers can use financial planning education to help employees understand the complementary role that these accounts and other 401(k)-type savings plans can play in a long-term saving strategy.