What is a Health Savings Account (HSA)?

As the cost of healthcare continues to increase, being prepared for medical expenses is important to all Americans and having a Health Savings Account (HSA) can help. An HSA is a personal savings account with a triple-tax advantage, which means you can make tax-deductible contributions , grow funds from interest and investments tax free, and withdraw money for qualified medical expenses tax free. To be eligible, you must be enrolled in a qualifying high-deductible health plan (HDHP).

Pairing an HSA with your HDHPs makes it easy to pay for your medical bills and save you money on medical expenses. While HDHPs do have a higher deductible plan amount, they offer a lower health insurance premium.

How does an HSA work?

Now that you know that Health Savings Accounts are tax-advantaged accounts available to help Americans save and pay for qualified medical expenses, you’re probably wondering if you’re eligible.

To open and contribute to a Health Savings Account you must meet the following requirements:

1. Enrolled in a high-deductible health plan (HDHP)
2. Not concurrently enrolled in any other non-HSA qualified health insurance plan
3. Not enrolled or eligible for reimbursement under a general-purpose Flexible Spending Account (FSA) Exception: A limited purpose FSA for dental and vision expenses is allowed if your HDHP doesn’t cover those services. A dependent care FSA does not disqualify you from being HSA-eligible
4. Not claimed as a dependent on someone else’s tax return
5. Not enrolled in Medicare (Part A or B) or Medicaid
6. 18 years of age or older

If you’re eligible you can set up your HSA account through a bank, credit union, insurance company, or other financial institutions that offer HSA account services.

Once you’ve got your account set up, you can make contributions to your HSA. If you made your contribution yourself, it is tax deductible even if don’t itemize your deductions. When you employers contribute to your HSA, it is not included in your gross income. Also, any interest or investment gains earned with the HSA are tax free.

Funds saved in your HSA can be withdrawn tax free to be used to pay for qualified medical expenses. Although qualified expenses are subject to change annually by the IRS, costs considered to be medically necessary are generally considered as qualified. Expenses that are for elective procedures (such as cosmetic purposes) are not.

HSAs are portable, meaning that the funds in the account belong to you even when you change jobs or insurance providers.

What is considered a qualified medical expense?

Every year the IRS establishes the qualified medical expenses for health plans in Publication 969. With an HSA you can pay wide variety of expenses including doctor visits, medications, medical equipment, and dental and vision care for you, your spouse, and any dependents.

What are the contribution limitations for an HSA?

Health Savings Accounts can be a valuable tool to save for medical care and retirement because of the tax savings when you make a contribution or withdrawal. However, the IRS has put rules around how much you can contribute to your savings each year and overcontributing can lead to unexpected tax penalties.

In 2023 and 2024, HSAs will have higher contribution limits, allowing you to save more on healthcare expenses.

Your maximum annual contribution is determined by whether you’re covering just yourself or a family too, and whether you’re 55 years old or older. 

• The maximum contribution for self-only coverage is $3,850
• The maximum contribution for family coverage is $7,750
• Those age 55 and older can make an additional $1,000 catch-up contribution

What are the advantages of having an HSA?

HSAs are personal savings accounts that can only be used for medical expenses. Besides ensuring that you are ready for any medical costs that might come up, there are many other advantages to having an HSA, including:

Lower healthcare costs – HSAs allow you to save for medical expenses and ensures that you have the funds readily available when you need it, therefore reducing any reliance on expensive loans or credit cards to cover your healthcare costs.

Flexibility and control over healthcare choices – With an HSA you are provided the ability to use your funds for a wide range of eligible expenses, including alternative and/or complementary treatments not typically covered by traditional health insurance plans.

Transferability – HSAs allow you to retain ownership and control of the account even when you have changed jobs or insurance providers. This means your account belongs to you no matter your employment situation.

Savings and investment opportunities – You can grow your HSA with the option to invest funds into stocks, bonds, mutual funds, and other investments to provide long term financial growth and increased savings for future medical costs.

Triple tax advantage – With HSA you can make tax-deductible contributions, incur tax-free growth on your investments, and withdraw money for qualified medical expenses tax free.

What are the tax benefits of having an HSA?

We just discussed how HSAs offer a triple tax advantage but what does that exactly mean come tax time?

Here’s how the HSA triple tax advantage works:

• All contributions you make to your account are 100% tax deductible which means any money you put in your account can be deducted from your gross income
• Any interest earned on the money in your HSA is 100% tax deferred meaning the funds can grow without be taxed unless they are used for non-eligible medical expenses
• Any money withdrawn from the account for eligible medical expenses is 100% tax-free
• HSA funds are not taxed if they are used for eligible medical expenses

HSA vs FSA vs HRA: What’s the difference?

HSAs, HRAs (health reimbursement arrangement), and FSAs (flexible spending account) are all bank accounts used to save on taxes and pay for qualified medical expenses.

If your employer doesn’t offer any health contributions and you buy your own health insurance, you’re only eligible for an HSA. However, your employer may contribute to any of these accounts and the choice will be yours.

Here’s how an HSA, HRA, and FSA compare:

8 strategies for maximizing your HSA contribution

Millions of Americans use their Health Savings Account to not only pay off medical costs without tapping into their regular checking and savings account but as a tool to save retirement too.

That is why it is important to use your working years to maximize your HSA contributions.

Here are some strategies to maximize your HSA contributions:

1. Contribute up to the IRS Limit – Every year the IRS publishes the annual set limit in Publication 969. Make sure to try and contribute that amount to your account every year.

2. Opt-in for payroll deductions – To ensure a consistent saving schedule allow your employer to take your HSA contribution from your paycheck with their automatic payroll system.

3. Catch-up contributions - If you’re 55 years or older, take advantage of  catch-up contributions which allow you to contribute an additional $1000 per year beyond the regular limit.

4. Plan for family contributions - If you have a family HSA plan, make sure you are making contributions to both your individual and family contribution limits.

5. Contribute early in the year – When you start making contributions early in the year you can take full advantage of the HSA’s triple tax benefit throughout the year.

6. Make long term plans – Use your HSA as a tool for your retirement savings by investing funds into low-cost, diversified investments for potential growth.

7. Leverage your employer contributions – If your employer offers to match your contribution, make sure you are making the maximum contribution yourself to get the most out of this benefit.

8. Keep track of your expenses – Make sure you keep all your receipts for your qualified medical expenses, so that you can reimburse yourself when necessary.

How to pay medical expenses with an HSA

Any money contributed to the HSA remains in the account until you decide to use it. There is no “use it or lose it” rule, unlike a Flexible Spending Account (FSA). In fact, funds can be carried over year to year so that you can build up savings for future medical expenses.

When you do have a qualified medical expense, you can withdraw money from your HSA to pay for it. Typically, you can access those funds through a debit card, checks, or online transfers.

For tax purposes, it is important that you keep records of your HSA account contributions and withdrawals to ensure that you contributed the right amount and used any funds on qualified medical expenses.

How to use an HSA for preventive care

Preventive care is a medical term that refers to preventing disease and helping doctors find problems before symptoms emerge. Preventive care normally refers to things like immunizations, lab tests, physical exams, and prescriptions.

At the highest level, preventive care is covered upfront at 100% with no deductible or copay. As an HSA user, you receive preventive care at no cost to you.

To provide a bit more context, for most healthcare expenses, your HDHP can’t provide benefits each year until you meet your deductible for that year. However, when the expense is for qualified preventive care, you’re able to bypass your deductible—meaning you receive immediate benefits for any care that falls under preventive care.

How to use an HSA for non-medical expenses

Once you’re 65 or older you can withdraw your HSA funds for non-medical expenses penalty-free (like buying a boat, for example), however, the funds used will still be subject to income tax.

If you use HSA funds for non-medical expenses before the age of 65, those funds will lose their tax-exempt status and will be subject to income taxes. Also, there is a 20% tax penalty for early non-medical withdrawals.

So, it is important to note that you will lose the tax benefit of any funds withdrawn from your HSA for non-medical expenses. 

Managing and keeping records for a health savings account

Finally, it is important to remember that you are the one responsible for whether your funds are spent on qualified medical expenses. This means you need to meticulous about keeping your HSA records and documents organized.

Here are three tips to managing your HSA records:

1) Know what eligible medical expenses are

This may sound obvious but before you spend your HSA funds make sure you understand what you can and can’t use that money on. Any expense must be considered a qualified medical expense to avoid tax penalties. The product or service provided must meet the IRS’s definition of medical care. In short that means primarily for the diagnosis, cure, treatment, mitigation, or preventive care for a medical condition.

2) Keep every receipt and statement

Hold onto all your HSA records for as long as your tax return is considered open, which is about three years after you file, or for as long as you have your health savings account.

These records include HSA purchase receipts, HSA account statements, employer contributions, and documents with product or service descriptions that you paid for.

If you can’t prove funds were spent on a qualified medical expense, you may face a 20% penalty on any distribution.

The only time you don't need a receipt showing the distribution was for an eligible medical expense is when you rollover funds into another HSA.  In this case, the distribution is accounted for on your tax return.

The IRS suggests keeping records to show that:

• The distributions were exclusively to pay or reimburse qualified medical expenses
• The qualified medical expenses had not been previously paid or reimbursed from another source
• The medical expenses had not been taken as an itemized deduction in any year

3) Make digital and physical folders

Now that you kept all those receipts and statements, it is time organize them. Create a digital folder with all your receipts, statements, and a spreadsheet to document your contributions to your HSA. Back up that digital folder by printing everything out and maintaining a physical folder too.

Though it may seem like a lot of paperwork, being prepared for the possibility of an IRS audit is crucial. Maintaining records of your HSA expenditure will help validate your expenses if the need arises.

The bottom line

A Health Savings Account makes paying for healthcare easier and less expensive.  These accounts offer a triple tax advantage for funds contributed, interest collected, and money withdrawn to use on qualified medical expenses. Plus, it will help you save on expenses once you retire. Learn more about finding the right HSA for your needs to make sure you are ready to take care of your medical needs.