What Is a Health Savings Account? Rules, Benefits & Drawbacks

Article Summary:

A health savings account (HSA) is a type of tax-advantaged account that can be used to pay for qualified medical expenses. HSAs are often called “triple tax-advantaged” because contributions you make to the account are deducted from your taxable income, you don’t pay taxes on earnings in the account, and future withdrawals from the account aren’t taxed as long as they’re used for eligible medical expenses. If you’re looking for a way to save money on taxes and protect yourself against rising healthcare costs, an HSA could be the solution.

According to Fidelity’s Retiree Health Care Cost Estimate, the average 65-year-old retired couple could need around $315,000 (in after-tax dollars) saved to cover healthcare expenses during their golden years.

Saving for the future can seem like a daunting task, but it’s important to start early so you can afford to live comfortably when you’re older. One way to start building up your nest egg is by opening a health savings account (HSA). Think of an HSA as a special bank account that allows you to save money tax-free, specifically for medical expenses.

Let’s dive deeper into how a health saving account works and how it could help you secure your financial future.

How does a health savings account work?

A health savings account allows you to set aside pre-tax income to cover healthcare costs. To get an HSA, you must first enroll in a high-deductible health plan (HDHP). HDHPs typically have lower monthly premiums than other types of health insurance, but they also have higher deductibles. This means you’ll have to pay more out-of-pocket before your insurance coverage kicks in. However, the money in your HSA can be used to cover your deductible and other qualified medical expenses.

This tax-advantaged account can be used to pay for a wide range of healthcare expenses, including infertility treatments, prescriptions, and dental care. Plus, the money in your HSA rolls over from year to year, and it belongs to you even if you change jobs or health plans. Though some HSAs only function as savings accounts, some HSAs allow you to invest a portion of your contributions in mutual funds, bonds, and stocks, helping you further maximize tax benefits.

Eligibility requirements

To be eligible for a health saving account, you must:

  • Be covered under a high deductible health plan (HDHP).
  • Not have any other health coverage, except for the plans permitted under the “Other Health Coverage” section in the IRS Publication 969.
  • Not be enrolled in Medicaid.
  • Not be claimed as a dependent on someone else’s tax return.

How do you contribute to an HSA?

Fortunately, the IRS mostly cares about how much you contribute to your HSA, not how the money gets there. You can contribute to your HSA in several ways:

  • Deposit or transfer. Contribute to your health savings account by writing a check, transferring money from another account, or depositing cash directly.
  • Payroll deduction. Most employers allow you to deposit money automatically into your health savings account by deducting a certain amount from your monthly paycheck.
  • One-time transfer from your IRA account. You can also make a one-time tax-free transfer from your IRA to your HSA. Remember that the transfer amount must be below the annual HSA contribution limit.

Maximum contribution limits

In 2022, the maximum amount you could contribute to your HSA was $3,650 for self-only coverage and $7,300 for family coverage. In 2023, the limits are slightly higher. For individuals, the contribution limit is $3,850, and families have a new limit of $7,750. And if you’re 55 and older, you can make catch-up contributions of an additional $1,000.

Keep in mind that the annual contribution limit applies to the total amount contributed by both the employer and the employee. If you exceed the contribution limit, you’re subject to a 6% excise tax each year until you remove the excess amount. So if you contributed $500 over the limit, you’ll need to pay $30 in penalties.

Pro Tip

If you contribute to your health saving account with after-tax dollars, you may be able to claim a tax deduction for your contribution amount when tax season rolls around. To make sure you claim the appropriate benefits, try using tax preparation software like one of those from the list below.

HSA-eligible medical expenses

Here is a list of some of the common IRS-approved HSA-eligible expenses:

  • Inpatient treatment at a therapeutic center for alcoholism or drug addiction
  • Laser eye surgery
  • Special education expenses (such as tutoring fees for children with learning disabilities)
  • Dental treatments (including X-rays, fillings, sealants, and cleaning)
  • Over-the-counter drugs and medicine
  • Hearing aids and batteries
  • Personal protection equipment such as masks and gloves
  • Infertility treatment, including in vitro fertilization (IVF) and egg, sperm, and embryo storage
  • Grooming, food, and veterinary care for guide dogs
  • Birth control treatment such as pills, injections, and devices like IUDs
  • Breast pumps and lactation supplies
  • Walkers and canes
  • Speech therapy
  • Physical therapy
  • Quit-smoking treatments such as nicotine gum and patches (if prescribed by a doctor)

HSA special considerations

Though there are multiple benefits of having an HSA, these accounts also come with a few drawbacks. Here are a few things you should keep in mind about health savings accounts.

  • Penalty for ineligible expenses. You’ll incur a 20% penalty on top of income tax if you withdraw money from your HSA to cover costs that aren’t considered IRS-approved HSA-eligible expenses. And though the 20% penalty won’t apply to you if you’re 65 or older, you’ll still have to pay income tax on non-qualified withdrawals.
  • Don’t exceed the annual contribution maximum. As we mentioned earlier, you can only contribute a certain amount of money to your HSA each year. If you exceed this amount, the IRS will impose a 6% tax on those excess contributions when you file taxes.
  • Complete Form 8889. If you’re the beneficiary of a health savings account, the IRS requires you to fill out Form 8889 when you file your tax return. In this form, you’ll report your distributions from your HSA and the contributions you’ve made throughout the tax year.

Pro Tip

Make sure to keep copies of receipts for expenses that were paid for with your HSA money. You’ll save yourself a lot of time and headaches during tax season by keeping records of your expenses throughout the year.


Do I have to use all of the money in my HSA every year?

No, you don’t have to use all of the money in your HSA funds each year (unlike a flexible spending account). Because the contributions you make to your health savings account are vested, any unused funds are automatically rolled over to the next tax year.

Can I open an HSA if I’m self-employed?

Yes. As long as you meet the eligibility requirements, you can open an HSA even if you’re self-employed or unemployed.

I just opened my account. How do I start using my HSA?

Once you open a health savings account, you can start making contributions through deposits, transfers, or payroll deductions (as mentioned above).

Then, when you incur qualified medical expenses — such as hospital expenses for inpatient and outpatient services — you can withdraw funds from your HSA to cover the costs. Some providers may give you a debit card or checkbook you can use to withdraw money from your health savings account. So check with your HSA administrator to see what options are available to you.

What’s a deductible?

In a nutshell, your deductible is the amount you need to pay out-of-pocket before the HDHP starts covering the cost. For 2022, the Internal Revenue Service defined high deductible health plans (HDHP) as plans with minimum deductible amounts of at least $1,400 for individuals and $2,800 for families.

What is the main benefit of a health savings account (HSA)?

The main benefit of an HSA is the tax advantages! Health savings accounts allow you to contribute pre-tax dollars (which lowers your taxable income), pay zero taxes on earnings, and withdraw your funds tax-free (as long as it’s used to pay for qualified medical expenses).

What is the main downside of an HSA?

The main disadvantage of having an HSA is that you must enroll in a high-deductible health plan to qualify. In other words, you must pay for your healthcare expenses out of pocket until you meet the deductible amount. Though the premiums with HDHPs are generally much lower than other healthcare plans, the high deductible amount can be burdensome if you’re on a tight budget.

Where can I open an HSA?

Many banks and credit unions offer health savings accounts. Some popular financial institutions that provide HSAs include Fidelity, Bank of America, and Optum Bank. You can also open an HSA through your employer if they offer one.

Key Takeaways

  • A health savings account (HSA) is a type of tax-advantaged account that can be used to pay for qualified medical expenses.
  • The contributions you make to your HSA are deducted from your taxable income. Plus, the earnings grow tax-free, and future withdrawals won’t be taxed as long as they’re used to pay for qualified medical expenses.
  • To qualify for an HSA, you must be enrolled in a high-deductible health plan (HDHP). Though HDHPs have lower monthly premiums than other types of healthcare plans, they have higher deductibles.
  • You can contribute to your HSA through payroll deduction or by making deposits or transfers into the account.
View Article Sources
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