What Is a Health Savings Account?

Vault’s Viewpoint on HSAs

• An HSA account is a savings account where you set aside pre-tax dollars for qualified medical expenses.
• You must be covered under a high-deductible health plan before you can contribute money to an HSA.
• You can open an HSA account through your employer or through a bank or investment firm.

What Is an HSA?

A health savings account (HSA) lets you set aside pre-tax money for qualified medical expenses. This type of savings account offers a triple tax benefit—the money you contribute is tax-free, the funds grow tax-free, and any money you deduct is tax-free.

But your withdrawals are only tax-free if you spend them on qualified medical expenses. If you withdraw the funds for some other purpose, you’ll pay income taxes on the money. You’ll also pay a 20% penalty if you’re under the age of 65.

Each year, the IRS sets a maximum contribution limit for HSAs. In 2024, the annual limit for individuals with self-only coverage is $4,150, and the limit for individuals with family coverage is $8,300.

What Are HSA-Eligible Expenses?

According to the IRS, medical expenses are anything used to alleviate or prevent an illness or disability. It also includes your insurance premiums and money you pay for transportation to receive medical care.

It doesn’t include expenses for expenses that are simply beneficial to your health, like a gym membership or supplements. Here are some examples of approved medical expenses:

• Annual physical exams
• Birth control
• Breast pumps and supplies
• Special equipment to provide medical care, like exit ramps, handrails or modified equipment
• Disabled dependent care expenses
• Hearing aids
• Hospital services

If you want more information, the IRS provides a complete list of HSA-approved expenses.

What is a High-Deductible Health Plan?

Before you can open an HSA, you must be enrolled in a high-deductible health plan. An HDHP is a plan with a higher deductible than traditional health insurance. Your monthly premium is lower, but you’ll have to meet your deductible before your health care coverage kicks in.

In 2024, the minimum deductible requirement for an HDHP is $1,600 for self-only coverage and $3,200 for family coverage. In addition, there’s an out-of-pocket maximum of $8,050 for self-only coverage and $16,100 for family coverage.

Pros and Cons of HSAs

There are many benefits to opening an HSA, but it won’t be the right choice for everyone. Here are some of the biggest advantages and drawbacks to consider.

Pros

• Triple tax advantage: HSAs offer a triple tax advantage—you contribute money tax-free, the money grows in your account tax-free and if you use the money for qualified medical expenses, you withdraw the money tax-free. This is an incredibly rare benefit.
• Investment opportunities: An HSA allows you to invest the funds in stocks, bonds and other financial investments. But some HSA providers require you to reach a minimum balance before you can start investing.
• Retirement planning tool: The money in your HSA continues to grow, and you won’t lose the funds if you don’t spend them. If you don’t withdraw any money from your HSA before age 65, you can use your HSA as a back-up retirement account.
• Employers can contribute: Your employer can contribute to your HSA, and unlike a 401(k), there are no required matching contributions from employees. If your HSA is set up through your employer, you can take the remaining balance with you if you leave your job.

Cons

• Must have an HDHP: You must be enrolled in a high-deductible health plan (HDHP) to be elgible for an HSA. With this kind of plan, you’ll have to meet a large deductible before your health insurance kicks in. Not everyone has the financial resources to manage this type of plan.
• Potential fees: If you withdraw money from your HSA before age 65 and use it for non-qualified medical expenses, you’ll have to pay income taxes and a 20% penalty. If you wait until age 65, the 20% penalty goes away, but you’ll pay taxes on any money you withdraw.

How to Open an HSA

Here are the steps you’ll take to open an HSA:

• Confirm you’re eligible: Before you open an HSA, you need to ensure you’re enrolled in an HDHP. If you’re uninsured or enrolled in any other type of health insurance plan, you can’t open an HSA.
• Pick your provider: If you’re enrolled in an HDHP, your next step is to pick your provider and open an HSA. Start by asking your employer if they offer a health savings account program. Letting your employer manage the account for you is much easier, especially if they make contributions on your behalf. If your employer doesn’t offer this benefit, you can open an HSA through a bank or qualified financial institution.
• Invest the funds: Once you’ve opened the account and started contributing money, don’t forget to invest the funds. Investing the money allows you to take advantage of compound interest and use this tool to its fullest extent.

Should I Open an HSA?

Opening an HSA account might make sense, particularly if your employer already offers this benefit. HSAs are a good option for anyone looking for a tax-free way to save for long-term medical expenses. And if you don’t end up using your HSA for medical expenses, you can use it to supplement your retirement.

The biggest drawback of opening an HSA is that it requires you to enroll in an HDHP. These plans come with high out-of-pocket costs, which may not be a good choice for anyone with high ongoing medical expenses. For example, if you have a chronic medical condition, you may be better served by a traditional health insurance plan.

If you’re on the fence about whether an HSA is the right fit for you, it’s a good idea to consult with a financial advisor. They can assess your needs and help you find ways to reduce your tax burden and cut down on medical expenses.