Health savings accounts provide a tax-advantaged way for individuals with high-deductible health plans (HDHPs) to save and pay for medical expenses. They offer a sizable degree of flexibility along with near-unmatched tax benefits. These pluses have made them a popular choice for people looking to manage healthcare costs both now and in the future. However, HSAs come with specific rules and requirements that must be followed in order to maintain the tax advantages.
A financial advisor can help you use your HSA funds effectively for medical expenses and retirement planning.
What Is an HSA and How Does It Work?
An HSA is a savings account designed to let individuals with high-deductible health plans (HDHPs) set aside money for qualified medical expenses. To encourage their use, HSAs come with unusually appealing tax benefits.
Once you open an HSA, you can make regular contributions up to the annual limit set by the IRS. These contributions can be made directly by you, through payroll deductions if your employer offers an HSA, or even by a third party, such as a family member.
Unlike a flexible spending account (FSA), where unused funds are forfeited at the end of the year, HSA balances roll over annually. Any money you don't spend can stay in the account. You can spend it in the following year or leave it in the account, allowing your savings to grow over time.
The funds in your HSA can be used to cover a wide range of healthcare expenses, including doctor's visits, prescription medications and dental care. Any funds in the account can be invested, much like a 401(k) or IRA. Upon reaching retirement age, you can even use the funds for non-medical expenses without penalty, though they will be taxed as ordinary income in that case.
HSA Rules and Requirements
HSAs are governed by specific rules to maintain their tax-advantaged status. Below, we'll discuss the key rules and requirements that HSA holders need to be aware of.
HSA Eligibility
To qualify for an HSA, you must be enrolled in a high-deductible health plan (HDHP). The IRS defines an HDHP as a health insurance plan with a minimum deductible of $1,600 for individuals or $3,200 for families in 2024 ($1,650 and $3,300 for 2025). Additionally, you cannot be enrolled in any other health insurance plan that is not an HDHP, including Medicare, and you cannot be claimed as a dependent on someone else's tax return (Note: Even if you aren’t claimed as a dependent but could qualify as one, you still can’t have an HSA).
HSA Contribution Limits
The IRS sets annual limits on how much you can contribute to an HSA. For 2024, the contribution limit is $4,150 for individuals and $8,300 for families ($4,300 and $8,550 for 2025). People aged 55 and older can also make a catch-up contribution of $1,000 each year. Contributions can be made by you, your employer or a family member, but the total contribution cannot exceed the annual limit. These limits are subject to change annually, so check the IRS guidelines each year.
HSA Qualified Expenses
HSA funds can only be used for IRS-approved qualified medical expenses. These include costs such as doctor's visits, prescription drugs, dental work, vision care and even certain over-the-counter medications. Using HSA funds for non-qualified expenses before age 65 will result in penalties as well as regular income taxes. After age 65, HSA withdrawals for non-medical expenses are free of penalties, but get taxed as regular income.
HSA Penalties and Fines
If you use HSA funds for non-qualified expenses before age 65, you will incur a 20% penalty, in addition to owing taxes on the amount withdrawn. To avoid penalties, only use HSA funds for qualified medical expenses or wait until retirement age when the penalty no longer applies. Additionally, if you over-contribute to your HSA beyond the annual limit, you will face a 6% excise tax on the excess contributions unless they are withdrawn by the tax filing deadline.
HSA Advantages
One of the biggest advantages of an HSA is its triple tax benefit. Here's how the triple advantage works:
- First, contributions to the HSA are tax-deductible, reducing your taxable income for the year.
- Second, the money in your HSA grows tax-deferred, meaning any interest, dividends or capital gains earned within the account are not subject to annual income taxes.
- Finally, withdrawals from the HSA are tax-free, as long as the money is used for qualified medical expenses.
Another key benefit is the flexibility that comes with an HSA. Unlike other health savings accounts, the funds in your HSA never expire. You can carry them forward year after year, making an HSA a long-term savings tool that can even be used for retirement healthcare costs. Additionally, HSAs offer investment options, allowing you to grow your balance over time by investing in stocks, bonds or mutual funds, similar to other retirement accounts.
Bottom Line
HSAs can offer significant tax benefits and provide a flexible way to save for current and future medical expenses. By understanding the eligibility criteria, contribution limits and rules governing the use of HSA funds, you can make the most of your account and avoid penalties. The triple tax advantage, combined with the ability to roll over unused funds year after year, makes HSAs an excellent tool for managing healthcare costs and planning for retirement. Always make sure that you follow the guidelines set by the IRS to maintain your account's tax-advantaged status and maximize your savings potential.
Tips for Health Savings Investing
- A financial advisor can help you create a financial plan to fund your medical expenses. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- If you invest in mutual funds or other securities through your HSA, watch out for high fees and other restrictions. Some HSA providers require high minimum investments, while others require none.
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