What Are the Downsides of a Health Savings Account?
Uncover the less-discussed challenges and specific conditions that can make Health Savings Accounts less ideal for some individuals.
A Health Savings Account (HSA) is a tax-advantaged savings and investment vehicle for healthcare expenses. Contributions are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are also tax-free. Despite these benefits, HSAs have limitations individuals should understand.
Eligibility Requirements and Health Plan Considerations
HSA eligibility requires enrollment in a High-Deductible Health Plan (HDHP) and generally no other health coverage, except for specific types like vision, dental, or long-term care. Individuals with non-HDHP insurance cannot contribute to an HSA.
For 2025, an HDHP must have a minimum annual deductible of $1,650 for self-only coverage or $3,300 for family coverage. Annual out-of-pocket expenses, including deductibles, co-payments, and coinsurance (excluding premiums), cannot exceed $8,300 for self-only coverage or $16,600 for family coverage. This structure means individuals pay substantial out-of-pocket costs before insurance coverage begins.
An HDHP can be a drawback for those preferring lower deductibles or with predictable, high medical costs. Individuals with chronic conditions may face significant upfront costs to meet the deductible, leading to higher immediate expenses. Other disqualifiers for HSA eligibility include Medicare enrollment or being claimed as a dependent.
Restrictions on Fund Usage
HSA funds are primarily for qualified medical expenses. These expenses, as defined by IRS guidelines, include deductibles, co-payments, prescriptions, and certain dental and vision care. Many common healthcare costs can be paid with tax-free HSA withdrawals.
Using HSA funds for non-qualified expenses before age 65 incurs significant penalties. Such withdrawals face a 20% penalty tax and are taxed as ordinary income. For instance, a $500 non-qualified withdrawal incurs a $100 penalty and is added to taxable income.
This restriction limits the financial flexibility of HSA funds, as they are primarily for healthcare. Individuals needing savings for non-medical emergencies before retirement may find this challenging. After age 65, funds can be withdrawn for any purpose without the 20% penalty, though non-qualified withdrawals are still taxed as ordinary income, similar to distributions from a traditional retirement account.
Investment Management and Volatility
Many HSAs offer an investment component, allowing funds to grow beyond a basic savings account, with earnings accumulating tax-free. This provides long-term growth potential but introduces market risk. Funds invested in stocks, bonds, or mutual funds are subject to market fluctuations, meaning the principal could decrease in value. This risk contrasts with the stability of a simple savings account where the principal is generally preserved.
Effective HSA investment management requires financial literacy or comfort with investing. Risk-averse individuals or those lacking investment experience might find this intimidating, potentially leading them to keep funds in cash. This choice, while reducing risk, can limit the long-term growth potential that makes HSAs attractive as a retirement savings vehicle.
Investing HSA funds requires administrative effort, including managing investments, monitoring performance, and rebalancing portfolios. Some HSA providers also charge monthly maintenance or investment fees. These fees can erode returns, especially for smaller balances, impacting overall growth.