Should You Switch to a Health Savings Account?

As the name implies, a Health Savings Account (HSA) is not traditional medical coverage, where you purchase an insurance policy by paying a premium and renewing it periodically. Instead, it enables consumers to set aside funds for potential future health expenses on a pre-tax basis. The amount you set aside for medical expenses reduces your taxable income, bringing down your tax burden.

HSA vs FSA

A Health Savings Account should not be confused with a Health Flexible Spending Account (FSA or section 125 plan). Those plans only cover expenses for the current tax year, but they have no contribution limits. The employee gets help paying for dependent care, transportation and his or her medical care, but loses any unused money remaining in the account at year’s end. This removes the chance they might abuse the plan to reduce the tax liability.

However, an HSA does have contribution limits, and you must enroll in a High Deductible Health Plan (HDHP), which is sometimes known as “catastrophic” health insurance. You can use an HSA in conjunction with an FSA to reduce your tax burned even more, but the FSA must be altered to a limited purpose plan. The FSA can be used for dental, vision and preventive care expenses that the HDHP did not cover.

Benefits of an HSA

If you don’t use the full amount you have contributed to your HSA in a given year, the funds will roll over to the following year. As the balance of your HSA increases, you will have the option of opening an investment account and transferring money into a combination of mutual funds, much like a 401K.

Once you have sufficient funds in your bank account, your will be able to reduce your contribution in the following year, and this will enable you to use some cash for your other expenses, if you decide to do so. Of course, you can also go on contributing and increasing the size of your HSA. Also, if you happen to pay medical bills out-of-pocket, you can reimburse yourself as soon as you have sufficient funds in your HSA, but you must be prepared to account for those payments and retain the related receipts.

With an HSA, individuals are encouraged to assume a more active role in maintaining their health because they are more aware of treatment expenses and more likely to ask for details on treatment. In general, patients who pay for treatment themselves are more likely to ask detailed questions and take a more active role in the decision making process for medical procedures.

Risks with an HSA

Before you sign up for an HSA, be sure that you know what taking that step entails, especially since it is so different from other health insurance plans.

At first, you may not have sufficient funds accumulated in your account to pay your medical bills, because you will be dealing with a $3,000 deductible. However, you will be able to make a partial payment of whatever you have in the account and pay the rest when you have accumulated more funds. You must also be prepared to keep an accurate record of your medical expenses and note when they were paid. Although these plans require more work, they have the potential to increase the employee’s take home pay through lower insurance premium and taxes.