5 Health Savings Account Mistakes to Avoid

Are you maximizing your HSA benefits?

couple looking at computer

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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. 

The average 65-year-old couple retiring in 2020 will spend approximately $295,000 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 maximizing its potential. That begins with avoiding these common mistakes. 

Confusing an HSA With an FSA

A flexible spending account 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 2021, pre-tax contributions to an FSA are capped at $2,750. With an HSA, you can contribute $3,600 if you have individual coverage and $7,200 for family coverage.

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

The other thing to know is that FSA contributions typically don't roll over in full from year to year (though plans can choose to allow up to $550 in 2021 to carry over for use in the next year). Alternatively, FSA plans can allow a 2.5 month grace period after the end of a plan year to spend unused funds.

Due to laws passed to assist with recovering from the coronavirus pandemic, employers can permit employees to carry over unused FSA funds from 2020 to 2021 and from 2021 to 2022.

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 and earn interest.

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

If you're already in your 50s, you might think that contributing to an HSA isn't 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. 

Let's say you contribute $6,000 a year to a family HSA from age 50 until you reach age 65 (you can no longer contribute to an HSA once you enroll in Medicare). Assuming you earn a 3% annual return and fall into the 25% 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 2021 and your employer matches 100% of what you save, you could contribute $1,800 and your employer could match the same amount. Matching plan structures differ, so check with your employer for specifics. If a match is available, it ultimately reduces the amount you have to save, allowing you to maximize savings in other areas.

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. Don't mistakenly think that's the only way to use HSA funds, though. 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 provide peace of mind to know that the money is there if you need it. 

Using an HSA for Ineligible Expenses

An HSA doesn't cover every health care expense. If you mistakenly use HSA funds to pay for an ineligible cost, that can lead to a tax bite. You'll owe regular income tax on the money, plus a 20% 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 save for retirement. If you stay healthy, an HSA could supplement anything else you're setting aside in tax-advantaged or taxable brokerage accounts. 

Article Sources

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  2. Internal Revenue Service. "Rev. Proc. 2020-45," Page 14. Accessed June 28, 2021.

  3. Internal Revenue Service. "Rev. Proc. 2020-32," Page 1. Accessed June 28, 2021.

  4. Internal Revenue Service. "Notice 2021-15," Page 4. Accessed June 28, 2021.

  5. Internal Revenue Service. "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans (2020)," Page 17. Accessed June 28, 2021.

  6. Internal Revenue Service. "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans (2020)," Pages 3, 10. Accessed June 28, 2021.

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  8. Internal Revenue Service. "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans (2020)," Pages 5-7. Accessed June 28, 2021.

  9. Internal Revenue Service. "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans (2020)," Page 10. Accessed June 28, 2021.