What Is a Health Savings Account (HSA)?

Medical costs can be unforeseen and expensive. And as we age, unfortunately, they tend to be more frequent. For this reason, it’s wise to put together ample savings to ensure you’re prepared — whether you’re still in the middle of your career or have reached retirement age. One way to do this is by opening a Health Savings Account (HSA), a savings vehicle that lets eligible individuals pay for qualified healthcare expenses.

This article will explain how HSAs work and detail the many tax advantages that come with them. We’ll also outline the basics of contributing to them, including the annual limits to keep in mind, as well as the pros and cons of opening one.

How Does an HSA Work?

A Health Savings Account (HSA) is a tax-advantaged savings account you can use to pay for various medical and dental health expenses. Available through banks, insurance companies, and financial services companies, it allows you to cover costs for deductibles, copays, and coinsurance.

If eligible for an HSA, you can contribute pre-tax dollars and take tax-free distributions for qualified expenses. HSAs aren’t available to everyone, however. To qualify for enrollment, you must meet defined criteria and must have a specific type of health insurance plan.

“You have to have a specific type of healthcare plan in order to contribute to an HSA—a high-deductible health plan,” or HDHP, says Erika Kullberg, attorney and personal finance expert. “You also can’t be listed as a dependent on another individual’s tax return and must not be enrolled in another health insurance plan, although some exceptions to this rule may apply.”

HDHPs may be available through your employer and differ in several ways from standard health plans, with a higher deductible being a primary contrasting factor. As of 2024, they carry the following requirements:

• Minimum deductible of $1,500 for self-only coverage and $3,000 for family coverage.
• Maximum annual deductible and out-of-pocket expenses of $8,050 for self-only coverage and $16,100 for family coverage.

“With [HDHP] plans, the monthly premium is usually lower, but you pay more out-of-pocket health care costs yourself before your insurance company starts to pay its share,” explains Chris Urban, CFP, RICP, founder of Discovery Wealth Planning.

Tax Advantages

HSAs have several unique tax advantages that make them a beneficial savings vehicle for medical costs and retirement. Specifically, they allow you to withdraw funds tax-free and once you reach a certain age, take distributions without penalty for non-qualified expenses.

Below is a breakdown of the tax benefits:

Tax-Free Withdrawals

One of the most notable qualities of HSAs is that you can withdraw funds tax-free, even though you contribute on a pre-tax basis. “An HSA is a triple-tax-free account,” says Urban. “You can contribute pre-tax dollars (typically through an employer), invest those dollars and then withdraw those dollars AND earnings tax-free for qualified medical expenses.”

Retirement Saving

HSAs also have distinct benefits when it comes to retirement planning. Normally, you must use the funds within the account to cover qualified medical expenses. However, according to Blake Whitten, a financial advisor at Whitten Retirement Solutions, “[A]fter 65, they are taxed at ordinary income rates, making HSAs a powerful tool for retirement healthcare planning.”

For example, if you’ve built up a sizable sum of money within the account and don’t foresee any immediate medical needs, you can begin to take taxed distributions like you might for a 401(k) or 403(b) retirement plan. And, unlike these other accounts, HSAs don’t have any required minimum distributions (RMDs), meaning you can hold the money in them indefinitely. As Whitten points out, though, you must be 65. Taking money before that incurs a steep 20% penalty.

Tax Deductible Contributions

Another advantage to keep in mind is that contributions to HSAs are tax deductible. Because you contribute on a pre-tax basis, you’re able to lower the amount of taxable income in any year you put money into the account.

“One way to stretch your savings further is by contributing your pre-tax dollars to an HSA. Once you do, your contributions become tax-deductible,” Kullberg emphasizes. “In other words, you will spend less on taxes, which can help alleviate some of the financial strain that comes with managing medical expenses.”

Contributions

Both you and an employer can make cash contributions to your HSA. For instance, if your workplace offers an HDHP, it might agree to put a certain percentage of money in an HSA, which could help you grow your savings on top of what you put in.

Other people, such as relatives or friends, can contribute to your HSA for you, even though they’re not the account holder. This can be helpful if someone would like to gift you funds or provide future financial aid.

The IRS imposes annual limits on how much you can put in, which often change each year. As of 2024, you can contribute a maximum of:

• $4,150 with self-only coverage.
• $8,300 with family coverage.

Pros and Cons of HSAs

HSAs are a useful tool to have at your disposal — whether you plan to cover the costs of expensive medical and dental events or save for retirement. Perhaps their most important draw, however, is their set of tax advantages, including the ability to pay for qualified expenses tax-free.

Here are some pros and cons to consider:

Frequently Asked Questions

Do HSAs have compound interest?

A major benefit of storing money in an HSA is that it includes compound interest. This means that the money you save can grow significantly over time, potentially much more than if you put it in a standard savings account.

Can you invest within an HSA?

After you reach a minimum dollar amount threshold, you can invest in your HSA. This is an effective way to grow the funds you’ve stowed in the account, maximizing the money you could have on hand to pay for qualified expenses or withdraw in retirement. Like a 401(k), you’ll likely get to select from a specified menu of mutual or index funds.

“HSAs offer flexibility beyond traditional health savings options, allowing for investment opportunities once a minimum balance is reached,” Whitten points out. “This feature can potentially grow savings over time, enhancing the account’s role in long-term financial health planning.”

Are HSAs tied to employers?

While having an HDHP through your job is a way to become eligible to open an HSA, the account belongs to you — not your employer. Therefore, if you were to leave the company for any reason, you maintain full control over the account and can still contribute and invest the funds.

Should I open an HSA?

If you’re eligible, opening an HSA and contributing to it can be a wise way to build a substantial emergency fund for unforeseen medical costs. According to Kullberg, “Contributing to an HSA is a really smart idea if you know you have a lot of big medical expenses coming up—like if you are pregnant or have a surgery scheduled.”

As noted, an HSA can also be another effective way to save for retirement, either for health-related expenses or for other miscellaneous uses. Though you must wait until you’re near full retirement age to access the funds at a normal tax rate for any reason, the account gives you some flexibility to diversify your funds in your post-working years.