The Benefits and Risks of a Health Savings Account

For years, the Affordable Care Act (ACA) has been the health law of the land. Its requirement that everyone purchase health insurance or face of a penalty was the hallmark rule that likely coerced millions of healthy, but previously uninsured adults, to enroll.

However, times are changing. President Trump made it very clear on day one in the Oval Office with his first executive order that the ACA, which is best known as Obamacare, is living on borrowed time. If Obamacare is soon to be no more, it leaves millions of Americans to once again examine their healthcare options to find what works best for them.

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Is a health savings account right for you?

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Though only one Republican Obamacare replacement plan has gained any steam in Congress thus far, the interesting similarity between this replacement plan and the seven-point healthcare reform outlined by Trump last year during his campaign is a reliance on health savings accounts, or HSAs.

Health savings accountshave been around for more than a decade, and they're designed to help cover the costs of certain eligible medical expenses. In order for you to qualify today for an HSA, a number of factors would need to be met.

• You need to be enrolled in a high-deductible health plan with a minimum deductible of $1,300 as an individual, or $2,600 for family coverage.
• You aren't currently enrolled in Medicare.
• You can't be claimed as a dependent by anyone else.

Should you qualify, the HSA contribution limit in 2017 for workers aged 54 and under is $3,400, or $6,750 for a family. If you happen to be age 55 and older, you get an added $1,000 catch-up contribution that can be tacked onto the above limits.

The clear benefits of a health savings account

So what's so special about a health savings account? Let's take a walk through some of the key benefits of a plan that some pundits have suggested could become the new 401(k).

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One of the initial allures is that money contributed to an HSA is considered pre-tax, meaning it can lower your current-year tax liability in much the same way a traditional IRA or employer-sponsored 401(k) contribution can. Also, instead of contributing your own money to a health savings account, it's becoming more common for employers to contribute to an employees' HSA on their behalf.

Money contributed to an HSA can also be carried over from one year to the next, as well as invested in an FDIC-insured savings account, or in some cases with mutual funds. The current tax law allows money in an HSA to grow on a completely tax-free basis until retirement (which we'll touch on a bit more later).

The primary benefit of the HSA is that it allows you to take funds from the account to be used for qualifying medical expenses on a penalty-free and tax-free basis. This means if you run into a potentially costly medical situation, you can lean on your HSA to bail you out, and as long as the medical expense is qualified, you won't owe a dime in taxes and won't have to pay a penalty. And, keep in mind that you're allowed to use your health savings accountfor qualified medical expenses regardless of your age! If you're wondering what a qualified medical expense is, HSABank.com offers a pretty comprehensive list, courtesy of the IRS.

One last benefit of an HSA is that accounts are typically linked to a debit card, making it exceptionally easy for the accountholder to pay for qualified medical expenses.

Not so fast! HSAs have downsides, too

However, just like any retirement plan, HSAs have downsides, too.

For instance, if you use your account to pay for any non-qualified medical expenses, you'll not only owe ordinary income tax on the money you withdraw, but you may have to pay a 20% penalty on top of it. Something to keep in mind is that health insurance premiums are one expense that's not included as "qualified" at the moment, meaning you'll still have to pay premiums out-of-pocket, or hope your employer covers them.

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Secondly, an HSA may not be the best path if you're already in a very low tax bracket or paying no taxes at all. The tax-free nature of the HSA is arguably one of its greatest allures, but there's little advantage to socking away thousands of dollars a year in an HSA if you're already paying a low tax rate. Plus, once you reach age 65 and qualify for Medicare, your HSA becomes treated like a standard retirement plan and you'll owe tax on money that's withdrawn.

You'll also need to take into consideration that some HSA providers charge a monthly fee or a transaction fee. These fees typically aren't very high, but over the life of having a health savings accountthey can eat into the nest egg you've built up to protect yourself against unexpected medical expenses and for retirement.

Lastly, and this is pertinent for as long as the ACA remains the law of the land, HSA funds can't be used to cover the eligible medical expenses of a child after age 24, even though the ACA allows children to stay on their parents' health plan until age 26. Long story short, "dependent" is defined differently for HSAs, which could leave you or your adult children saddled with a large medical bill.

A health savings account isn't for everyone -- nor can a majority of workers qualify for an HSA at the moment. However, with the Trump administration and Congress seeming to favor an expansion of what HSAs can pay for and who can qualify, it's probably smart to know the ins and outs of this critical program in the years to come.

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