Health Savings Accounts, or HSAs, are tax-advantaged accounts American can use for medical expenses. They can also save employers on health insurance costs.
However, HSAs have many benefits beyond cost savings.
Here’s what you need to know about HSAs, HSA contribution limits and why it’s a good idea to max out your annual HSA contributions.
Table of Contents
- What is a Health Savings Account?
- 2022 HSA Contribution Limits
- What Happens If I Contribute Too Much to an HSA?
- Can You Contribute If You Aren’t Eligible for the Entire Year?
- Benefits of Maxing Out Your HSA Account Each Year
- Where to Open an HSA Investment Account
What is a Health Savings Account?
Health Savings Accounts are tax-advantaged savings accounts explicitly for health care spending. Yearly HSA contributions are tax-deductible and grow tax-free. Withdrawals are also tax-free when you use the money for qualified medical expenses.
In essence, a Health Savings Account is very similar to a combination of a Traditional IRA (tax deductible when you contribute) and a Roth IRA (no taxes on qualified withdrawals for medical expenses).
Health Savings Account Eligibility
You must participate in a qualifying High-Deductible Health Plan (HDHP) to be eligible for an HSA.
In 2022, a plan may qualify as an HDHP if the deductibles are $1,400 per year or higher for individuals, or $2,800 per year or higher for a family plan.
In 2023, A plan qualifies as an HDHP if its deductibles are at least:
- $1,500 per year for individuals
- $3,000 for families
These deductibles are higher than average, hence the name, High-Deductible Health Plan.
IRS rules for HDHP also limit out-of-pocket expenses. For 2022, these limits are $7,050 for self-coverage only and up to $14,100 for family coverage.
In 2023, HDHP out-of-pocket expenses cannot exceed:
- $7,500 for individuals
- $15,000 for families.
Employers may offer high deductible plans for enrollees who prefer to pay a lower monthly premium.
Higher deductibles can save policyholders money if they don’t go to the doctor often. The HSA option incentivize policyholders to become smarter with their healthcare spending by planning ahead for it with a pre-tax HSA.
However, you must save enough to pay the entire deductible, if necessary. Only choose an HDHP if you have some money set aside in an emergency fund or cash savings.
Tax Advantages of Health Savings Accounts
You can set aside pre-tax income in an HSA for use specifically on health spending, just like with a Flexible Spending Account (FSA).
However, HSAs have a key advantage over FSAs.
With an FSA, if you do not spend the funds in your account by the end of the year, you forfeit the remaining balance to the plan administrator.
With an HSA, you never lose the funds. You can set aside money this year in an HSA and use it 40 years from now. You can even pay for health care costs out of pocket now, and use your HSA to save for medical costs in retirement.
As long as the funds are used for healthcare spending, you won’t pay any tax on the withdrawals.
2022 HSA Contribution Limits
How much money can you set aside for future healthcare spending with an HSA?
The maximum annual contribution depends on whether you are on an individual or family plan. The 2022 maximum HSA contribution limit is $3,650 per year for an individual, while families can contribute $7,300.
In 2023, individuals can contribute $3,850 and families can contribute $7,750.
If you’re 55 or older, you can make $1,000 in catch-up contributions.
Note: Catch-up contributions for retirement accounts start at age 50.
You can contribute to this year’s HSA through April 15 of next year.
Here is a list of contribution limits from recent years, including the HSA contribution limits from 2010 – 2023:
|Tax Year||Individual||Family||Catch-Up Contributions
(age 55 and over)
What Happens If I Contribute Too Much to an HSA?
If you are automatically contributing funds to your HSA through payroll deductions, it won’t be possible to contribute too much to aHealth Savings Account. However, it is possible to over-contribute by making deposits outside of the payroll system.
If you discover you have contributed too much to your HSA, you must take action to avoid paying penalties to the IRS.
Remove any excess funds you contributed, plus any interest earned on that amount. You must pay tax on this withdrawal before April 15 of the following year.
If you fail to remove the excess contribution by the April 15 deadline, you must pay a 6% excise tax when you withdraw the funds later. Additionally, if you leave the funds in your account indefinitely, you must pay the 6% tax each year.
Alternately, you can 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, If you had an HSA contribution limit of $3,650 in 2022, but paid $3,750, you would have contributed $100.
You could avoid paying the 6% excise tax by only contributing $3,550 next year (the 2022 $3,650 contribution limit minus $100). If you contributed the full $3,650 next year, you’d have to pay the 6% tax on the original $100 over-contribution.
Can You Contribute If You Aren’t Eligible for the Entire Year?
Rarely do you start a new job on Jan. 1 or end it on Dec. 31. The date you gain and lose access to a high deductible health plan impacts your eligibility to contribute to an HSA.
Here is what the IRS says about gray area HDHP enrollees:
- The last-month rule allows eligible individuals to make a full contribution for the year, even if they were not a qualified individual for the entire year. Individuals can make the total contribution for the year if:
- They are eligible individuals on the first day of last month of their taxable year. For calendar taxpayers, this is Dec. 1).
- They remain qualified individuals during the testing period. (Dec. 1 of the current year to Dec. 31 of the following year).
- 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 rule uses the sum of your monthly contributions, which 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 Jan. 1 to Dec. 31 of the following year.
Pro-Rated Contribution Rules Explained
You can avoid tax problems with your HSA by pro-rating you contributions.
- First, divide your contribution limit by 12 to get your monthly contribution limit. For individuals, it is $304.16 and for families $608.33 (both numbers represent the 2022 tax year; use the current tax year’s contribution limit when calculating for your situation). Remember, each month that you had at least one day active in an HDHP counts as a full month for your contribution limit.
- Next, multiply the number of months you were active in the health plan by your monthly contribution limit. For example, if you started a new job and gained access to an HDHP on March 12 and maintained HDHP coverage through Dec. 31, you would have 10 months of pro-rated contribution availability. In this situation, you could contribute $304.16 x 10 = $3,041.60 for 2022. If you contributed the full amount of $3,650, you would need remove and pay taxes on the excess or reduce your 2023 contribution to avoid an HSA overcontribution penalty.
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. You receive an immediate tax benefit when you start making contributions. And, 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.
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 you make them (like a Traditional IRA). The earnings and withdrawals are tax-free (like a Roth IRA) as long as you use them for qualifying medical expenses.
HSAs don’t have an age limit. You can let your money ride until you need it, even if that’s after you retire.
What If You Want to Use Your HSA for Non-Qualifying Medical Expenses?
If use HSA funds for anything other than a qualifying medical expense, you must pay taxes and a 20% early withdrawal penalty (early withdrawal penalties for retirement accounts are 10%).
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 your toolbox’s most powerful financial tools.
Benefits of Long-Term HSA Ownership
I maximized my HSA contributions each year I was eligible to contribute to an HSA. To take advantage of the investment opportunities through the HSA, we elected to pay our medical costs out of pocket and continue investing the 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 decide 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 if necessary. If we’re 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.
Where to Open an HSA Investment Account
You first need to 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 exchange. You could also 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, 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, low fees, and they make it very easy to invest your funds through a brokerage. The bank will waive its fees if you maintain a certain minimum in your account.
HSA Bank offers two investment options. Lively and TD Ameritrade. I chose to invest with TD Ameritrade, because of its excellent reputation and access to several hundred fee-free ETFs for trading.
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.
If you can swing it, try to pay your medical expenses out of pocket to let your HSA contributions grow tax-free indefinitely, increasing your net worth.