5 Health Savings Account Mistakes to Avoid

Hispanic couple looking at computer

Ariel Skelley/Getty Images 

A Health Savings Account is more than just a way to save for future medical expenses. It can also yield certain tax advantages, while potentially shoring up your retirement strategy. 

That's important, considering that the average 65-year-old couple will spend approximately $275,000 on health care in retirement. That figure doesn't include the cost of long-term care, which can add thousands of dollars to the total. 

Medicare can pick up the tab for some of your health care costs in retirement, but it doesn't cover everything, including long-term care. That's where an HSA can be invaluable. You can withdraw funds from your HSA tax-free for qualified medical expenses. And, you can also tap your HSA for other financial needs—with a tax caveat, of course. 

If you've got access to a Health Savings Account, it's important to make sure you're using it to its full advantage. That begins with avoiding these common mistakes. 

Confusing an HSA With an FSA

A Flexible Spending Arrangement is another type of tax-advantaged savings account for health care. While the abbreviations for FSAs and HSAs are similar, there are some important differences to be aware of if your employer gives you the option of using either plan. 

First, an HSA allows you to save more for health care. For 2017, pre-tax contributions to an FSA are capped at $2,600. With an HSA, you can contribute $3,400 if you have coverage and $6,750 for family coverage. The HSA limits are set to climb to $3,450 and $6,900, respectively, in 2018. 

So why is that important? FSA contributions reduce your taxable wages, while HSA contributions are tax-deductible. Either way, you get a tax break but if you max out your HSA, that could yield a larger tax benefit at the end of the year. 

The other thing to know is that FSA contributions don't roll over from year to year. With an HSA, however, you can leave the money in your account until you need it. That means you don't have to frantically try to spend down those contributions each year. Instead, you can allow them to grow. 

Assuming an HSA Isn't Worth It If You're Older

If you're already in your 50s, you might think to contribute to an HSA is worth your time. At this point, for instance, you may be focused on playing catch-up with your 401(k) plan or an individual retirement account. That doesn't mean, however, that you can't still leverage an HSA later in life. 

Assume that you're 50 years old and contribute $6,000 a year to an HSA, until you reach age 65. (Remember, you can no longer contribute to an HSA once you enroll in Medicare.) Assuming you earn a 3 percent annual return and fall into the 25 percent tax bracket, you could accumulate roughly $115,000 for health care costs on a tax-deferred basis. Even if you save less than that, every dollar you put away could be used to offset medical costs in your later years. 

Missing Out on Employer Matching Contributions

A 401(k) isn't the only way to snag some free money in the form of a company match. Employers also have the option of offering a matching contribution to employee Health Savings Accounts. The catch is that total contributions to the account—including what you and your employer put in—can't exceed your annual contribution limit. 

That means if you have individual coverage for 2017 and your employer matches 100 percent of what you save, you could contribute $1,700 and your employer could match the same amount. Your plan's matching structure might be different but it's worth checking your plan to see if a match is available, since that reduces the amount you have to save. 

Not Thinking Big Picture

The primary function of an HSA is to help you enjoy some tax benefits while saving money for health care costs down the line. That's not, however, the only way to use HSA funds. Once you reach age 65, you can withdraw money from an HSA for any purpose, with no penalty. You would, however, have to pay ordinary income tax on anything you withdraw that isn't used for medical purposes. 

That's important to know, especially if you haven't poured as much money into your employer's retirement plan or an IRA as you would have liked. Even if you don't end up needing to draw on an HSA to cover living expenses in retirement, it can ease your peace of mind to know that the money is there if you need it. 

Not Knowing What Health Care Expenses an HSA Can Be Used For

An HSA can be used to pay for health care but it doesn't cover everything. If you mistakenly use HSA funds to pay for a non-eligible cost, that can create a tax bite. You'll owe regular income tax on the money, plus a 20 percent additional tax penalty if you're under age 65.

Bottom line? If you've got a Health Savings Account, be sure to read over the details of your plan carefully so you know what's covered and what's not. And don't count an HSA out if you're older, or if you have other accounts that you're using to saving for retirement. If you stay healthy, an HSA could help to supplement anything else you're setting aside in tax-advantaged or taxable brokerage accounts