What to Know About Health Savings Accounts (HSAs)

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Written By Charlotte Avery Young

Health Savings Accounts (HSAs) have become an increasingly popular tool for managing healthcare costs while also providing individuals with significant tax benefits. If you have a high-deductible health plan (HDHP), you may be eligible to open an HSA, but understanding how these accounts work and how to make the most of them is crucial. In this article, we’ll break down what an HSA is, how it works, its tax advantages, and tips on how to maximize the benefits of an HSA.

What is an HSA?

A Health Savings Account (HSA) is a tax-advantaged savings account that allows you to set aside money to pay for qualified medical expenses. HSAs are designed to work alongside high-deductible health plans (HDHPs), which typically have lower monthly premiums but higher deductibles than traditional health insurance plans.

The funds in an HSA can be used for a wide range of medical expenses, including doctor visits, prescription drugs, dental care, vision care, and even some over-the-counter items. The key advantage of an HSA is that it allows you to save for these expenses in a tax-efficient way.

How Does an HSA Work?

Eligibility To open an HSA, you must be enrolled in a qualified high-deductible health plan (HDHP). As of 2024, the IRS defines an HDHP as a plan with a deductible of at least $1,600 for an individual or $3,200 for a family. Additionally, you cannot be covered by other health plans, including Medicare, and you cannot be claimed as a dependent on someone else’s tax return.
Contributions You (and your employer, if applicable) can contribute money to an HSA. The annual contribution limits for 2024 are:
- $4,150 for individual coverage
- $8,300 for family coverage
- $1,000 catch-up contribution if you’re age 55 or older.

Contributions to an HSA are tax-deductible, meaning the money you contribute reduces your taxable income for the year. This is one of the key tax advantages of an HSA.

Withdrawals Funds in an HSA can be used tax-free to pay for qualified medical expenses. The IRS defines qualified medical expenses as those that are primarily for the prevention or alleviation of physical or mental health conditions, including doctor visits, hospital care, prescription medications, and even some types of therapy.

It’s important to note that if you use HSA funds for non-qualified expenses, you’ll face a penalty (20% if you’re under 65) and the amount withdrawn will be subject to income tax. However, if you’re over age 65, you can use HSA funds for non-medical expenses without facing the penalty, though you’ll still owe income tax.

Roll Over Funds One of the unique advantages of an HSA is that the funds you don’t use roll over year after year. Unlike a Flexible Spending Account (FSA), which has a “use-it-or-lose-it” policy, HSA balances can accumulate indefinitely. This allows you to build a growing fund that can cover medical expenses in the future, even into retirement.
Investment Options Once your HSA balance reaches a certain threshold (often around $1,000 or $2,000, depending on your HSA provider), you may have the option to invest the funds in stocks, bonds, mutual funds, or other investment vehicles. The growth of your HSA investments is tax-free, and when you use the funds for qualified medical expenses, withdrawals are also tax-free. This makes the HSA an attractive long-term investment vehicle, especially for those who are looking to save for healthcare costs in retirement.

The Tax Advantages of HSAs

HSAs are often called the "triple tax advantage" account, because they offer three key tax benefits:

Tax-Deductible Contributions: The money you contribute to your HSA is deducted from your taxable income, which reduces your overall tax liability for the year.
Tax-Free Growth: The funds in your HSA can grow tax-free, whether through interest, dividends, or investment gains. This is a significant benefit for long-term savers who can invest their HSA funds and allow them to appreciate over time.
Tax-Free Withdrawals for Qualified Medical Expenses: When you use the funds in your HSA for eligible medical expenses, withdrawals are not subject to income tax.

These tax advantages make the HSA an incredibly powerful tool for individuals looking to save for healthcare costs both now and in the future. Additionally, because HSA funds are not subject to income tax, they can serve as a form of tax-advantaged savings for retirement.

Key Benefits of HSAs

Lower Taxes With the triple tax advantage, HSAs can significantly lower your tax burden. For example, if you’re in a 24% tax bracket and contribute the maximum allowable amount to an HSA, you could reduce your taxable income by $4,150 (for individual coverage in 2024), potentially saving you over $1,000 in taxes.
Long-Term Savings Potential Unlike many other accounts designed to pay for medical expenses, HSAs allow you to save for the future without worrying about expiration dates. As long as you keep receipts for medical expenses, you can even delay withdrawing from your HSA until later years, allowing your account to grow tax-free and providing a powerful way to fund healthcare costs in retirement.
Flexibility HSAs provide flexibility in how you use your funds. You can use them for current medical expenses, save for future medical costs, or even invest them for future growth. If you leave your job, your HSA remains yours—unlike a health FSA, which is tied to your employer.
Healthcare Costs in Retirement Healthcare costs in retirement can be significant, and an HSA is one of the best ways to plan for them. The average 65-year-old couple can expect to spend over $300,000 on healthcare in retirement. By building up HSA savings while you’re working, you can prepare for those costs with tax-advantaged funds that will be available when you need them.

Potential Drawbacks of HSAs

Eligibility Limitations The requirement to have an HDHP means that not everyone will be eligible for an HSA. Additionally, some individuals may not want to switch to an HDHP, as these plans come with higher deductibles and out-of-pocket costs before insurance coverage kicks in.
Penalties for Non-Qualified Withdrawals If you withdraw money from your HSA for non-qualified expenses before the age of 65, you’ll face a 20% penalty in addition to income tax. While this penalty disappears after age 65, using your HSA for non-medical expenses should be avoided unless absolutely necessary.
Contribution Limits While the contribution limits for HSAs are generous, they may not be sufficient for people with high healthcare costs. If you have significant medical expenses, you might need to rely on other savings or investment accounts in addition to your HSA.
Complexity in Managing the Account While HSAs are an excellent financial tool, managing one can be complex. You must keep track of receipts for medical expenses, manage your investments, and ensure that you only withdraw funds for qualified expenses. Many HSA providers offer user-friendly tools, but some people find it cumbersome to manage their accounts effectively.

How to Maximize Your HSA

Contribute the Maximum Amount: Try to contribute the maximum allowable amount each year to take full advantage of the tax benefits. If you can, contribute on a pre-tax basis through payroll deductions to maximize your tax savings.
Invest Your HSA Funds: If your HSA balance is large enough to qualify for investments, consider investing the funds in low-cost index funds or other growth-oriented options. This can help your account grow faster, providing you with more funds for future medical expenses.
Keep Track of Medical Expenses: Keep receipts for any eligible medical expenses, as you can reimburse yourself from your HSA at any time—even in future years.
Use Your HSA as Retirement Savings: If you’re in good health and don’t have many medical expenses now, consider saving your HSA funds for retirement healthcare costs. The ability to withdraw funds tax-free for qualified medical expenses makes the HSA a powerful tool for managing healthcare in your later years.

Conclusion

Health Savings Accounts (HSAs) are one of the most tax-efficient ways to save for current and future medical expenses. With their triple tax advantages, the ability to roll over funds indefinitely, and the potential for investment growth, HSAs can be a key part of your long-term financial planning. However, to fully take advantage of this powerful tool, it’s important to understand the eligibility requirements, contribution limits, and best practices for managing your HSA. If used correctly, an HSA can help you save on taxes, provide a cushion for healthcare costs, and secure your financial future.