What is an HSA?
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BLUEPRINT
Published 9:15 a.m. UTC June 3, 2024
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Key points
- An HSA is a tax-advantaged way to save for qualified medical expenses.
- HSA money used for nonqualified expenses may be subject to taxes and penalties.
- The IRS limits who can contribute to an HSA and how much.
Health care spending is on the rise in the U.S. According to data from the Centers for Medicare and Medicaid Services, health care spending is projected to increase to $20,425 per person in 2031. That’s up from $13,413 per person in 2022. While insurance covers some health care costs, many people will likely see out-of-pocket expenses increase too.
It may be impossible to avoid all health care costs. But a health savings account provides powerful tax advantages. It also offers the ability to set aside money for most medical expenses.
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What is a health savings account?
An HSA is a savings account that lets you set aside money to pay for qualified medical expenses. It has a triple tax advantage. Your contributions, investment growth and withdrawals are all tax-free.
The money in your HSA doesn’t have to sit there and stagnate until you spend it. Some HSAs let you invest your money, including in mutual funds or exchange-traded funds.
How an HSA works
An HSA offers serious benefits to those who are eligible to open one. But you must understand the contribution and withdrawal rules upfront.
HSA eligibility
You can contribute to an HSA only if you have a high-deductible health plan. Eligible plans must meet government requirements for a minimum deductible and a maximum out-of-pocket cost.
In 2024, an HDHP is a health plan with a deductible of:
- $1,600 or more for an individual.
- $3,200 or more for a family.
It must also limit out-of-pocket costs to:
- $8,050 for an individual.
- $16,100 for a family.
HSA contribution rules
There’s also a limit to how much you can contribute to your HSA each year. In 2024, you can contribute up to:
- $4,150 with an individual HDHP.
- $8,300 with a family HDHP.
Your contribution limit increases by $1,000 if you’re 55 or older.
If you have a qualifying plan for only part of the year, you can contribute a prorated amount. This is based on the length of time you were enrolled in an HDHP.
Your HSA contributions are tax-deductible. In other words, they reduce your taxable income for the year and help you lower your tax bill.
HSA withdrawal rules
Withdrawing your HSA funds is straightforward. But there are some rules.
Your HSA money is meant to be used for qualified medical expenses for you, your spouse or your dependents. As long as you follow that rule, you can enjoy continued tax benefits.
“If you use the money for qualified medical expenses, it’s tax-free every time,” said Greg O’Brien, a certified public accountant and co-CEO of the CPA firm Anomaly. “However, if you use it for nonqualified expenses before age 65, you’ll pay income tax and a 20% penalty.”
The HSA withdrawal rules change once you reach age 65. At that point, your HSA operates much like a retirement account. You can use the funds for any purpose. Money withdrawn for something other than qualified medical expenses will be subject to income tax only.
HSA qualified expenses
You must spend your HSA money on qualified medical expenses. Otherwise, your withdrawals will be subject to income tax and a 20% penalty.
According to the IRS, qualified medical expenses are “the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body.”
“Suppose a medical or dental expense is eligible to be considered for meeting your deductible,” said Alissa Krasner Maizes, a licensed attorney and registered investment advisor and the founder of the fee-only advisory firm Amplify My Wealth. “In that case, it is likely an HSA-qualified expense.”
Examples of qualified medical expenses
The definition of qualified medical expenses is broad. You can spend your HSA money on more than medical bills.
Here are some examples of qualified medical expenses provided by the IRS:
- Abortion.
- Acupuncture.
- Alcohol and drug addiction treatment.
- Ambulance.
- Artificial limbs and teeth.
- Bandages.
- Birth control pills.
- Braille books and magazines.
- Breast pumps and supplies.
- Chiropractor.
- Contacts and glasses.
- Crutches.
- Dental treatment.
- Diagnostic devices.
- Home improvements and vehicle upgrades to accommodate a disability.
- Lead-based paint removal.
- Legal fees related to treatment.
- Lodging if you travel to receive medical care.
- Oxygen.
- Pregnancy test.
- Special education.
- Smoking cessation programs.
- Surgery.
- Transportation to and from medical care.
- Weight-loss program.
The list of qualified medical expenses goes far beyond the above examples and includes hundreds of possibilities. You can use your HSA money for over-the-counter medications for allergies or digestive health, for example. There are even online databases that allow you to look up specific products to see if they’re covered.
Note: You generally can’t use your HSA money for private health insurance premiums. But there are exceptions if you have COBRA continuation coverage through a former employer or receive federal or state unemployment compensation.
Pros and cons of an HSA
HSAs are popular savings tools that help you pay for medical expenses. Like other tax-advantaged accounts, HSAs have pros and cons.
Pros
- Triple tax advantage. An HSA offers a triple tax advantage. Your contributions, investment growth and withdrawals are all tax-free as long as you follow IRS rules.
- Ability to invest. You can potentially invest your HSA money, building a nest egg for retirement or qualified medical expenses.
- Unlimited rollovers. HSA money carries forward indefinitely and doesn’t expire or disappear.
- Full ownership. You own your HSA and the money in it. If you leave your job, you bring your HSA funds with you. You can use your HSA funds even if you can no longer contribute to the HSA.
- Retirement savings. Withdrawals are no longer subject to the 20% penalty when you reach age 65. This makes HSAs similar to traditional individual retirement accounts.
Cons
- Limited eligibility. You can contribute to an HSA only if you have an HDHP. The higher deductible could be larger than the tax savings you receive.
- Withdrawal penalties. You’ll owe income tax on nonqualified withdrawals. They’ll also be subject to a 20% penalty.
How to use your HSA for retirement
An HSA could be a smart addition to your retirement savings strategy. You can use two approaches.
The first is to pay for your current medical expenses out of pocket and save the receipts. Then invest your HSA balance and let it grow. In retirement, you can reimburse yourself for past medical expenses using the receipts and create a tax-free income stream.
The second is to treat your HSA like a traditional IRA. Invest your contributions and begin taking withdrawals at age 65. At this time, distributions will be subject to regular income tax. And there’s no penalty for using money for nonmedical expenses.
Frequently asked questions (FAQs)
Anyone with an eligible high-deductible health plan qualifies to open and fund an HSA. In 2024, an eligible plan has a deductible of at least $1,600 for individual coverage and $3,200 for family coverage. It also limits annual out-of-pocket costs to $8,050 and $16,100 for individual and family plans, respectively.
An HSA offers triple tax benefits. Contributions are tax-deductible. Money in the account grows tax-free. And withdrawals for qualified for medical expenses are tax-exempt. For this reason, HSAs are generally considered among the most valuable savings vehicles.
You should contribute the maximum amount allowed to your HSA each year if possible. The money rolls over year after year and can be invested for use in retirement.
But balance your HSA deposits with other financial needs. For example, you should have an emergency fund for expenses other than health care. Pulling money out of your HSA before age 65 for a nonmedical reason will result in a 20% tax penalty.
Yes, both preventive dental services and dental treatments can be paid for using an HSA. But teeth whitening is not a covered service.
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