Health Savings Accounts, or HSAs, are growing in popularity among people who need affordable health insurance and among employers looking to save on health insurance costs. HSAs have many benefits beyond cost savings. Let’s dive in and take a look at what exactly is a health savings account, the HSA contribution limits for each calendar year, how HSAs are one of the most flexible financial accounts you can open, and why it’s a good idea to max out your annual HSA contributions.
What is a Health Savings Account?
Health Savings Accounts are a type of tax-advantaged savings account specifically for health care spending. Contributions are tax deductible in the year they are made, and grow tax free. To be eligible for an HSA, you need to participate in a qualifying High Deductible Health Plan (HDHP) for health insurance. A plan may qualify as a HDHP if the deductibles are $1,350 per year or higher for individuals, or $2,700 per year or higher for family plan.These deductibles are typically higher than average, hence the name, High Deductible Health Plan.
Advantages of HDHPs. Many people choose these health insurance plans because they typically have lower monthly premiums due to the high deductible. Many employers offer these HDHP plans for the same reasons. The goal of the higher deductibles is to save costs for everyone, incentivize policy holders to become smarter with their healthcare spending, and give you the option of setting aside money pre-tax to pay for healthcare. On the flip side, you need to have sufficient funds to pay your portion of the deductible. So only choose a HDHP if you have some money set aside in an emergency fund or cash savings.
Tax advantages of Heath Savings Accounts. You can set aside pre-tax income in an HSA for use specifically on health spending. HSAs are often compared to and confused with Flexible Spending Accounts (FSAs). The two are similar in that you set aside pre-tax income for health costs, but FSAs have a serious downside that HSAs do not. With an FSA if you do not spend all of the funds in your account by the end of the year you forfeit the remaining balance of your account to the plan administrator. With a Health Savings Account you never lose the funds. In fact, you could set aside money this year in an HSA and use it 40 years from now (some people even pay for their health care out of pocket now, and use their HSAs as another way to save for retirement). And as long as the funds are used for healthcare spending, you won’t pay any tax on the withdrawals.
2018 HSA Contribution Limits
How much money can you set aside for future healthcare spending with an HSA? The maximum annual contribution is dependent upon whether you are on an individual or family plan. The maximum HSA contribution limit is $3,450 per year for an individual, while families can contribute $6,900. There is also a catch up contribution limit of $1,000 for those whoa re age 55 or older (note: catchup contributions for retirement accounts start at age 50).
Here is a list of contribution limits from recent years, including the HSA contribution limits from 2010 – 2018:
|Tax Year||Individual||Family||Catch-Up Contributions
(age 55 and over)
What Happens If I Contribute Too Much to an HSA?
If you are contributing funds to your HSA automatically through payroll deductions it should be virtually impossible for you to contribute too much to your Health Savings Account. However, it is possible to over-contribute by making deposits outside of the payroll system or simply through error.
If you discover you have contributed too much to your HSA, you must taken action to avoid paying penalties to the IRS. The fix is quite simple: you must remove the excess amount contributed, plus any interest earned on that amount, and pay tax on both before April 15th of the following year. (You can contribute to this year’s HSA through April 15 of next year.) You received a tax break by putting the money into your HSA pre-tax, but since you contributed too much you technically should have paid tax on the original income.
Failure to remove the excess contribution by the April 15th deadline and then withdrawing the funds at a later date will result in a 6% excise tax when you do withdraw the funds. Additionally, if you leave the funds in indefinitely, each year you must pay the 6% tax.
However, there is one way to get out of having to remove the contribution and paying tax: leave the contribution in, but avoid the 6% excise tax by lowering the next year’s contribution by the amount of the over-contribution. For example, an individual with an HSA contribution limit of $3,400 per year would have been guilty of contributing $100 too much if they contributed $3,500 this year. They could avoid paying the 6% excise tax by only contributing $3,300 next year (the $3,400 contribution limit minus $100). If they contributed the full $3,400 next year, they would then be forced to pay the 6% tax on the original $100 over-contribution.
Can You Contribute if You Aren’t Eligible for the Entire Year? Pro-Rated Contribution Rules Explained
Rarely do you start a new job on January 1st or end it on December 31st. When you gain and lose access to a high deductible health plan will impact your availability to contribute to an HSA. If you are not active in a HDHP for the entire year your situation is a gray area. Here is what the IRS says in one of it’s instruction manuals:
Last-month rule allows eligible individuals to make a full contribution for the year even if they were not an eligible individual for the entire year. They can make the full contribution for the year if:
- They are eligible individuals on the first day of last month of their taxable year. For most people this would be December 1, and
- They remain eligible individuals during the testing period. The testing period runs from December 1 of the current year through December 31 of the following year (for calendar taxpayers).
- If the taxpayer does not qualify to contribute the full amount for the year, the contribution is determined by using the sum of the monthly contribution limits rule.
- Sum of the monthly contribution limits rule (use Limitation Chart and Worksheet in Form 8889 Instructions). This is the amount determined separately for each month based on eligibility and HDHP coverage on the first day of each month plus catch-up contributions. For this purpose, the monthly limit is 1/12 of the annual contribution limit, as calculated on the Limitation Chart and worksheet.
In other words, you can contribute the full amount if you are eligible as of Dec 1, of the calendar year. However, you may owe back taxes if you do not remain eligible from January 1 – December 31 of the following year.
To avoid tax problems, your HSA contribution can be pro-rated. Simply divide your normal contribution limit by 12 to get your monthly contribution limit. For individuals it is $283.33 and for families $562.50 (both numbers represent the 2017 tax year; just apply the current tax year to your situation). Each month that you had at least 1 day active in a HDHP counts as a full month for your contribution limit. Then simply multiply the number of months you were active in the health plan by your monthly contribution limit.
For example, an individual that started a new job and gained access to a HDHP on March 12th and maintained HDHP coverage through December 31st would have 10 months of pro-rated contribution availability. They could contribute $283.33 x 10 = $2,833.30 for the year. If they contributed the full amount of $3,300 they would need to take the steps listed above to avoid penalties for over-contributing to their HSA.
IRS Publication 969 has more info about HSA qualifications, contribution limits, distribution rules, and more.
Benefits of Maxing Out Your HSA Account Each Year
There are numerous advantages to having an HSA. There is the immediate tax benefit in the year you make your contribution. And since your savings never expire, you can save the funds in your HSA or a linked investment account, and let your savings and investments grow over time. In fact, this can be a brilliant investment strategy:
Using Your HSA as a Super Retirement Account
Health Savings Accounts combine the best of the Traditional IRA and Roth IRA. Contributions are tax-deductible in the year they are made (like a Traditional IRA), and the earnings and withdrawals are tax-free if used for a qualifying medical expense (like a Roth IRA, when used for retirement). There are no age limits when using your HSA funds for a qualifying medical expense. So you can let your money ride until needed. Or just let it grow and pay your medical expenses out of pocket.
What if you want to use your HSA for non-qualifying medical expenses? If used for anything other than a qualifying medical expense, you will pay taxes and a 10% early withdrawal penalty, just as you would with a retirement account. However, the rules change a little bit once you turn age 65. Once you reach age 65, the current tax rules allow you to make non-qualifying withdrawals from your HSA with the same tax rules as a Traditional IRA. So you would pay taxes on the withdrawals, but you would not pay any penalties.
This flexibility makes your HSA one of the most powerful financial tools in your toolbox.
Benefits of Long Term HSA Ownership
I maximized my HSA contributions each year I was eligible to contribute to an HSA. We decided to take advantage of the investment opportunities through the HSA, so we elected to pay our medical costs out of pocket and invest our HSA funds. My health insurance plan has since changed, and I am no longer eligible to contribute to an HSA plan. However, I am not required to remove those funds until I decide to use them for medical expenses, or I decide I wish to withdraw the funds for other purposes.
Since the funds are invested, I’d like to let them compound as long as possible. If we have a major medical expense, I can elect to pay for them with our HSA savings. And if we are lucky and don’t have any expenses we can’t pay out of our cash flow or savings, then I will have a large investment account I can tap into when I reach retirement age. I’m hoping for the latter!
Where to Open an HSA Investment Account
The first thing you need to do is qualify for an HSA with a compatible High Deductible Health Care Plan. Check with your employer if you have an employer-sponsored health care plan. If not, then you may be able to purchase a qualifying HDHP on the ACA exchanges, or find one through a health insurance company such as eHealthInsurance (this is where I always found our health care plans after I became self-employed).
Once you have a qualifying health care plan, you can shop around for different banks or investment accounts that offer HSAs. I wrote an article about the process of opening an HSA account, which bank I chose, and why.
I decided to open my HSA account with HSA Bank, in part because they have easy access, very low fees (which can be waived if you maintain a certain minimum in your account, and because they make it very easy to link your HSA account to a brokerage where you can invest your HSA funds. HSA Bank offers two investment options. I chose to invest with TD Ameritrade, because of their excellent reputation and access to several hundred fee-free ETFs for trading. So I’ve never paid anything to make a stock purchase at TD Ameritrade because I invested in ETFs that didn’t have any associated trading costs.
Health Savings Accounts are one of the most flexible financial accounts you can open. If you are eligible to open an HSA, I recommend maxing out your contributions each year. And if you can swing it, try to pay your medical expenses out of pocket. This will allow your HSA contributions to grow tax free indefinitely, allowing you to increase your net worth.