How Does An HSA Work (And Why You Should Use One)

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A health savings account (HSA) is a type of savings account that allows you to put money aside for eligible medical expenses.

But how do you know if an HSA is right for you?

Since I don’t know all of your personal information and I’m not a financial advisor anyway, I can’t tell you for certain whether or not you’re a good fit for an HSA.

But what I can do is walk you through my decision making process and why I decided to sign up for a health saving account for the first time in 2018. I’ll also explain why that decision has worked out so well for my family.

How Does An HSA Work?

The first health savings accounts were introduced in 2003, and since then they have become more and more popular with people looking to manage their healthcare costs.

As the cost of healthcare continues to skyrocket, the popularity of HSAs will only continue to grow.

To qualify for an HSA you must be covered under a high deductible health plan (HDHP).  In 2020, the minimum deductible for an individual is $1,400. For a family it is $2,800.

That means if you’re a family you need to be prepared to drop $2,800 towards your deductible before insurance kicks in.

That’s a hefty bill and not everyone is prepared to pay it.

But don’t worry:

You can use the power of an HSA to cover those costs.

HDHPs generally charge a lower monthly premium (I’ll walk you through my actual costs in a minute) and the idea is to deposit those monthly savings into a health savings account so it is there when you need it.

My employer pulls money out of my paycheck and automatically deposits it into my HSA just like my 401(k) contributions.

Automating your savings is definitely the way to go.  If your employer doesn’t offer that option you’ll have to be extra disciplined to make sure you keep funding your health savings account.

For 2020 the maximum contribution amounts are $3,550 for individuals and $7,100 for families.

That may seem like a lot but remember you’re likely saving through lower monthly premiums and let’s be realistic, healthcare costs are only going to rise in the future.

Your HSA contributions are pre-tax and any interest and earnings on them will also grow tax free. Any withdrawals you make to cover eligible medical expenses are also completely tax free, though you will pay income tax and a penalty tax if you withdraw the funds for something else, like a new car or a kitchen remodeling.

Also, any funds you don’t use this year roll over for use in future years. The account is always yours. You won’t lose it if you don’t use it like you would with a flexible spending account.

Let’s recap and look at the advantages and disadvantages of health savings accounts…

Pros and Cons of HSA Accounts

Pros

  • Contributions to an HSA account are made pre-tax so they will lower your taxable income for the year.
  • Your employer may make a matching contribution which is like free money.
  • Health savings accounts are portable, which means if you change jobs you can take your account with you.
  • You can invest your HSA balance so it earns interest and dividends. This will help it grow faster.
  • There is no “use it or lose it” concern like there is with flexible spending accounts.
  • It’s like having a medical emergency fund that will be there when you need it.
  • If you follow all the rules, it is a way to save money completely tax free.

Cons

  • HSA accounts only work with high deductible plans so your out of pocket medical costs could be higher than with a traditional medical plan.
  • Medical expenses are unpredictable. You may be healthy now but you never know when something will happen and you could end up paying more than you planned for.
  • Good record keeping is vital. You need to save those receipts and keep everything organized.
  • Your money is tied up and can only be used for medical expenses.
  • If you have a non-medical emergency and need to tap into your HSA, you will be hit with taxes and penalties.

Why I Decided To Open A Health Savings Account

I’ve been frustrated by healthcare costs for years. We’re a family of five and we’re all relatively healthy but I seem to spend a lot of money on medical expenses.

My insurance premiums go up every single year and the coverage seems to get worse and worse as copays and deductibles continue to increase.

Plus I seem to be constantly fighting with insurance carriers over what and how much is covered even over basic expenses.

I was actually sent to collections once over a $60 bill that I argued should have been covered by insurance. I sometimes think they just default everything to “not covered” just to see how much they can get us to pay without questioning it.

So when open enrollment came around I decided to spend some time crunching the numbers instead of just going with what I had chosen in prior years.

The results absolutely floored me and I realized a health savings account was clearly the way to go.

Let’s take a look at the key numbers for both options:

Traditional Medical Plan POS Option

  • Biweekly premium: $404
  • Family deductible: $1,500
  • Maximum out of pocket: $7,000

HDHP Plan with a Health Savings Account

  • Biweekly premium: $119
  • Family deductible: $4,000
  • Maximum out of pocket: $7,350

In terms of coverage levels and copays, everything else is pretty much the same so the stats above are the key numbers in the decision-making process.

Right off the bat you can see that the plan with the HSA has much lower premiums but a deductible almost three times as much as the traditional plan.

But which is the better option?

Some simple math will give us the answer.

Let’s start with the traditional medical plan I’ve been using all along.

I get paid every other week so to figure out how much my annual premiums will be I just need to multiply the per paycheck premium by 26.

$404 x 26 = $10,504

It’s important to note that whatever you pay toward premiums is gone no matter how much or how little you go to the doctor.

Under the traditional health plan option I would be paying $10,504 just for the privilege of having medical insurance.  That doesn’t even include any co-pays or other out of pocket expenses.

Even if my family went the entire year without a cold, injury, or checkup we’d be out over $10,000.

Add in the cost of the $1,500 deductible and we would have to spend $12,000 before insurance kicked in at all.  And even then we’d still have to pay twenty percent of all costs until we hit the $7,000 maximum out of pocket.

Fortunately we’ve been lucky to date and we’ve never paid anywhere near the maximum in a year, but who knows what the future holds.

Now, let’s run the numbers using the high deductible plan and the HSA.

$119 per paycheck x 26 pay periods = $3,094

Holy smokes!  That’s a difference of $7,410!

Even when you factor in the increased deductible (from $1,500 to $4,000) I still come out way ahead by opting for the HSA.

I would only have to pay out $7,094 (premiums plus deductible) before insurance kicks in and begins covering eighty percent of eligible expenses.

But wait, it gets better.  My company offers a $1,000 employer contribution when you sign up for the HSA and fund it through automated payroll deductions.

That is free money that will help me cover the cost of the higher deductible.  That’s just too good to pass up.

Our HSA Experience So Far

Two years into our HSA experience and I gotta say its been a huge win for my family. I’ve had less money coming out of my paycheck which means more money to put toward savings or paying down debt.

Also, we’ve actually had more medical expenses than usual for the last two years. My oldest daughter had calf issues that caused her to miss most of her high school track season, and my middle child needed braces which cost several thousand dollars.

If we didn’t have the HSA money sitting there ready to be tapped, these expenses would have caused me some serious stress and anxiety. But because I had the money on hand, I was able to cover them without any issue at all.

Plus, despite our higher than normal medical bills, we still didn’t use our entire contribution in either year. Those leftover funds will stay in our HSA and be available for use in future years.

In the meantime, I have a few thousand dollars as a buffer within the HSA where it earns a small amount of interest, and I’m also able to invest a portion in mutual funds where they can grow at a much faster rate.

Conclusion

Health care is expensive and it’s not going to get cheaper anytime soon.  Signing up for a health savings account is one way to minimize your out of pocket expenses and set up a fund for future medical expenses that will grow tax free.

After doing my research and running the numbers, I decided to switch to a high deductible health plan with a health savings account.

The way I see it, I’m basically taking the money I would have paid toward insurance premiums (which is gone no matter what) and putting it into an HSA instead.

If we have a really tough year with lots of medical expenses the money will be there for us.

On the other hand, if we have a good year and don’t incur many medical expenses the money can stay in the HSA and continue to grow and be available for future expenses.

Worst case, we use it all up every year and have nothing left to roll over.  Best case, we only use a portion each year and the account grows into a sizable next egg for when we are older.

Am I concerned about never using it?

Heck no.  Have you seen the cost of health care lately?  We’re only going to get older and eventually our health will start to fail us.

And I’ll sleep a little easier at night knowing we have a medical emergency fund set aside to help cover our bills of the future.

Reminder – I am not a tax or financial expert and none of this article should be taken as advice. It’s important to always look at your own situation and run the numbers yourself before making a decision about opening a health savings account.

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