Should I Max Out My HSA Contributions?

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The tax benefits of health savings accounts (HSAs) make them a good option for many people. You get a tax deduction when you contribute to an HSA and pay no taxes upon withdrawal as long as the money is used for medical expenses. Not everyone qualifies for an HSA, but if you do, should you max out your contributions? Here's how to decide.

What Is an HSA?

An HSA is a tax-advantaged savings plan you can use to cover certain health care costs. You put pretax income into the plan and can withdraw it tax-free if you use it for qualified medical expenses. These include health insurance deductibles, copayments, coinsurance, dental and vision care, prescriptions, over-the-counter medications and more.

Your employer may offer an HSA, and may even contribute to it or match a percentage of your contributions. You can also open an HSA yourself with a financial institution—such as a bank, credit union or institution that manages IRAs—that serves as an HSA trustee.

To open an HSA, you must participate in a high-deductible health insurance plan (HDHP) and have no other health insurance (although there are exceptions made for specialized health insurance such as dental and vision care). For 2021, the IRS defines an HDHP as one with a deductible of $1,400 or more for an individual or $2,800 or more for a family.

HSAs are similar to flexible spending accounts (FSAs) that allow account holders to set aside pretax money and withdraw it tax-free to use for health care and dependent care expenses. However, there are some important differences between the two:

  • Unlike HSAs, FSAs are only available through your employer.
  • If you don't spend your FSA money by the end of the plan year, you can lose it—although some employers give you a grace period of up to two and a half extra months to use it or let you roll over up to $550 for the following year. If you don't use your HSA money, however, 100% of the funds roll over to the next year. The amount rolled over doesn't count toward the following year's contributions. Recent federal law allows more flexibility with FSA limits if your employer chooses to adopt them.
  • Since your FSA is tied to your employment, you may lose the funds when you retire or leave your job. Your HSA funds always belong to you, even if you retire or leave your employer.
  • FSAs can be used only for qualified expenses. HSA money can be used for non-qualified expenses, but the amount you withdraw will be subject to income tax as well as a 20% additional tax. Once you're 65, you can use your HSA for non-qualified expenses. You'll still pay taxes on these withdrawals, but no additional tax penalties.
  • Unlike FSAs, HSAs can be invested in mutual funds or other investment vehicles and grow tax-free.

How HSAs Can Save You Money

HSAs offer triple tax benefits. You can contribute to an HSA through pretax payroll deductions or deduct your contributions on your federal income taxes. Interest, dividends or capital gains on your HSA are not taxed, and you can withdraw the money tax-free for qualified medical expenses.

Although HSAs can't be used to pay health insurance premiums, they can save you money on health insurance in other ways. HDHPs have lower premiums than traditional health insurance, but can ultimately be more expensive if you have a costly health care event and have to pay a lot out of pocket to meet your deductible. By helping you build an emergency health care fund, an HSA reduces the financial risk of an HDHP.

For example, if you're comparing a traditional family health insurance plan that has a $466 monthly premium and a family HDHP with a $395 monthly premium (the average costs for such plans in 2020), opting for the HDHP would save you $852 a year. If your employer contributes to your HSA, you'll enjoy even more financial benefits: In 2020, the average employer contribution to an HSA for family coverage was $1,018.

When you do withdraw HSA funds for health care expenses, you'll be paying with tax-free money. Don't need to use the money? It will keep accumulating in your account for when you do need it.

Should You Contribute the Maximum to Your HSA?

The 2021 maximum HSA contribution is $3,600 for individual HDHP coverage and $7,200 for family HDHP coverage. (Any employer contributions count towards these maximums.) If you'll be 55 or older by the end of the tax year and aren't enrolled in Medicare, these limits increase by $1,000. So, should you max out your HSA?

If you can afford to contribute the maximum to your HSA while meeting your other financial goals, there's no downside to doing so. If you're trying to choose between funding your HSA and your 401(k), the decision is more complicated. Start by taking advantage of any "free money" offered by your employer.

  • If your employer contributes to your HSA, open an HSA and fund the minimum amount needed to get the contribution.
  • If your employer matches your HSA contribution, contribute enough to max out the match.
  • If your employer matches your 401(k), contribute enough to max out that employer match.

When weighing your options, make sure to look at the big picture, including the rate at which your employer matches contributions to your HSA or 401(k), and whether you're fully vested in your 401(k) or plan to stay with your employer long enough to attain it. A fully vested employee who can take advantage of a generous contribution match from their employer might prioritize their 401(k) over their HSA.

If you can afford to contribute more to your HSA, making the maximum contribution each year can be a smart retirement savings strategy. An HSA lets you save for future health care expenses without paying taxes when you withdraw the money, as you'd do with a 401(k). It can also ensure you don't have to tap your retirement funds early for unexpected medical expenses—and pay the associated taxes and penalties. (Some 41% of Americans who withdrew 401(k) funds in the pandemic did so to pay medical expenses.)

Of course, you don't have to max out your HSA to see benefits. Put $50 or $100 into your HSA each month starting in your 20s and let it grow until retirement. Depending on how you invest the HSA, you could be well on your way to the $295,000 it's estimated a couple retiring today will need to pay for health care in retirement.

Make the Right Decision About Your HSA

When deciding whether to contribute the maximum to your HSA, be sure to consider your budget, other financial goals such as buying a home, whether you need to pay down debt or build up an emergency fund, and the potential investment returns from the HSA compared to your 401(k). There's no one-size-fits-all answer to the question of maxing out your HSA, but by carefully assessing your current financial situation and your projected future needs, you can make the best decision for yourself and your finances.

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