What is a Health Savings Account (HSA)?
A Health Savings Account (HSA) is a tax-advantaged account created for individuals covered under high-deductible health plans (HDHPs) to save for qualified medical expenses. Contributions are made into the account by the individual or their employer and are limited to a maximum amount each year.
The contributions to an HSA are invested over time and can be used to pay for qualified medical expenses, such as medical, dental, vision care, and prescription drugs.
Key Takeaways
- A Health Savings Account (HSA) is a tax-advantaged account to help you save for medical expenses that are not reimbursed by high-deductible health plans (HDHPs).
- No tax is levied on contributions to an HSA, the HSA’s earnings, or distributions used to pay for qualified medical expenses.
- An HSA, owned by an employee, can be funded by the employee and the employer.
- Contributions are vested, and unused account balances at year-end can be carried forward.
How an HSA Works
To qualify for a Health Savings Account (HSA), you must meet eligibility standards established by the Internal Revenue Service (IRS). You must:
- Have a qualified HDHP.
- Have no other health coverage.
- Not be enrolled in Medicare.
- Not be claimed as a dependent on someone else’s tax return.
The maximum contribution for an HSA in 2024 is $4,150 for an individual ($3,850 for 2023) and $8,300 for a family ($7,750 in 2023). The annual limits apply to the total amounts contributed by both the employer and the employee. Individuals age 55 or older by the end of the tax year can make catch-up contributions of an additional $1,000 to their HSAs.
An HSA can also be opened at certain financial institutions. Contributions can only be made in cash, while employer-sponsored plans can be funded by the employee and their employer. Any family member or other person can also contribute to the HSA of an eligible individual. Self-employed or unemployed individuals may also contribute to an HSA, provided they meet the eligibility requirements.
Individuals who enroll in Medicare can no longer contribute to an HSA as of the first month of enrollment. However, they can receive tax-free distributions for qualified medical expenses.
HSA Special Considerations
HDHPs have higher annual deductibles but lower premiums than other health plans. The financial benefit of an HDHP’s low-premium and high-deductible structure depends on your personal situation.
The minimum deductible required to open an HSA is $1,600 for an individual or $3,200 for a family for the 2024 tax year ($1,500 and $3,000, respectively, for 2023). The plan must also have an annual out-of-pocket maximum of $8,050 for self-coverage for the 2024 tax year ($7,500 for 2023) and $16,100 for families for the 2024 tax year ($15,000 for 2023).
When you pay qualified medical expenses equal to a plan’s deductible amount, additional qualified expenses are divided between you and the plan.
Example of HDHP
For example, if you had an annual deductible of $1,600 (in 2023) and a medical claim of $3,500, you would pay the first $1,600 to cover the annual deductible. Then, you’d pay 10% to 20% of the remaining $1,900, and the insurance company would cover the rest.
Once the annual deductible is met in a given plan year, the plan typically covers any additional medical expenses, except for any uncovered costs under the contract, such as co-pays. The insured can withdraw money accumulated in an HSA to cover these out-of-pocket expenses.
Advantages and Disadvantages of an HSA
HSAs have several advantages and drawbacks. The effect of these accounts depends on your personal and financial situations.
Pros
- Contribution Tax Advantages: Employer and individual contributions by payroll deduction to an HSA are excluded from the employee’s taxable income. An individual’s direct contributions to an HSA are 100% tax deductible from the employee’s income. Earnings in the account are also tax-free.
- Distribution Tax Advantages: Distributions from an HSA are tax-free when used for qualified medical expenses as outlined by the IRS.
- Investment Options: The money in your HSA can be invested in stocks and other securities, potentially allowing for higher returns over time.
Cons
- Deductible Requirements: You must have a high-deductible plan, lower insurance premiums, or be affluent enough to afford the high deductibles and benefit from the tax advantages.
- Requires Extra Cash: Funding your HSA requires enough spare cash to set aside, making it challenging for individuals who may find the high deductible amounts burdensome.
- Filing Requirements: HSAs come with filing requirements regarding contributions, specific rules on withdrawals, distribution reporting, and a record-keeping burden that may be difficult to maintain.
Withdrawals Permitted Under an HSA
Withdrawals from an HSA aren’t taxed as long as they are used for services treated as qualified medical expenses by the IRS. The plan’s manager will issue an IRS Form 1099-SA for distributions. Qualified medical expenses include:
- Deductibles, dental services, vision care, prescription drugs, co-pays, psychiatric treatments, etc.
- Insurance premiums are not a qualified medical expense unless for Medicare or healthcare continuation coverage (age 65+), health insurance when receiving healthcare continuation coverage (COBRA), unemployment compensation, or long-term care insurance.
Withdrawals for non-qualified medical expenses are subject to income tax and an additional 20% tax penalty. However, once an individual turns 65, the 20% tax penalty is eliminated, and only income tax would apply for non-qualified withdrawals.
HSA Contribution Rules
Contributions made to an HSA do not have to be used or withdrawn during the tax year. Any unused contributions can be rolled over to the following year. Additionally, an HSA is portable, meaning you can keep your HSA even if you change jobs.
An HSA can be transferred to a surviving spouse tax-free upon the account holder’s death. If the designated beneficiary is not the account holder’s spouse, the account is no longer treated as an HSA, and the beneficiary is taxed on the account’s fair market value, adjusted for any qualified medical expenses of the decedent paid from the account within a year of the date of death.
HSA vs. Flexible Spending Account
The HSA is often compared with the Flexible Spending Account (FSA). Here are some key differences:
- FSAs are employer-sponsored plans.
- Only employed individuals can sign up for FSAs.
- Unused funds in the FSA during a given tax year can’t be rolled over and are forfeited once the year ends.
- Your elected contribution amount for an FSA is fixed, unlike HSA contributions.
The maximum contribution for an FSA for the 2024 tax year is $3,200 ($3,050 for 2023).
Frequently Asked Questions About HSAs
Can I Open a Health Savings Account (HSA) If I’m Self-Employed?
You can open a Health Savings Account (HSA) if you have a high-deductible health plan. If you are self-employed, explore HSAs offered by brokerages or banks. Research your options carefully to ensure you get the best HSA to suit your needs.
Do I Have to Use All of the Money in My HSA Every Year?
Unlike a Flexible Spending Account (FSA), contributions to your Health Savings Account (HSA) can roll over yearly. Since the funds can also be invested, you can build capital for more significant medical needs or use it as an investment fund after retirement.
Can I Pay My Insurance Premiums with My HSA Funds?
In most cases, no. HSAs can be used for most medical expenses but not your monthly premiums. Exceptions are paying Medicare or healthcare continuation coverage premiums while on unemployment compensation or long-term care insurance.
The Bottom Line
HSAs are among the best tax-advantaged savings and investment tools available under the U.S. tax code. They are often referred to as triple tax-advantaged because contributions are not subject to tax, the money can be invested and grown tax-free, and withdrawals are not taxed when used for qualified medical expenses.
As you age, medical expenses tend to increase, especially upon reaching retirement age and beyond. Therefore, starting an HSA early and allowing it to accumulate over a long period can significantly benefit your financial future.
Related Terms: High-Deductible Health Plan (HDHP), Flexible Spending Account (FSA), Medicare, 401(k), self-employed.
References
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Pages 2 and 3.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 6.
- Internal Revenue Service. “Rev. Proc. 2023-23”.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 6.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 5.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 7.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Pages 3–4.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 4.
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- U.S. Securities and Exchange Commission. “Investor Bulletin: Health Savings Accounts (HSAs)”.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Pages 8–10.
- Internal Revenue Service. “Topic No. 502 Medical and Dental Expenses”.
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- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 10.
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- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 10.
- Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans”, Page 9.
