What Is a Health Savings Account?

An HSA is a savings account that lets you pay for qualified medical expenses using pre-tax dollars. Paying for medical expenses with untaxed dollars can help you save money in the long run, but you can only be eligible for an HSA if you meet specific stipulations like having a high-deductible health plan. They’re considered triple-tax-advantaged because you pay no taxes on:

1. Income you contribute.
2. Investment earnings.
3. Funds you withdraw for qualified medical expenses.

HSAs are set up with a “trustee,” usually a bank or insurance company, and are usually coordinated with your employer or health plan provider. But you can set up an HSA on your own, too, as long as you have a high-deductible health plan. You, your employer, and any other person – like a family member – can contribute to the account. Contributions are invested by the trustee and any investment income earned is added to your account balance. You can then withdraw funds to pay for qualified medical expenses, tax-free. 

The maximum amount you can contribute each year is limited by the IRS and adjusted periodically. Experts often recommend maxing out HSA contributions if you can. In 2020, you can contribute up to $3,550, or $7,100 for families.² If you are 65 years of age or older, you can also make catch-up contributions of $1,000.³ 

Most HSAs will provide you with a debit card and/or checkbook to pay for qualified medical expenses. But sometimes you may need to pay out-of-pocket and submit a claim for reimbursement. Either way, it’s important to keep receipts and expense documentation.

There are a few specific requirements to be eligible for an HSA:⁴

• You must have a high-deductible health plan (HDHP), which is a health insurance plan that has a lower-than-average monthly premium but a higher deductible – meaning you pay more money out-of-pocket before your health insurance kicks in.
• You have no other health coverage, though there are a few very specific exceptions.
• You aren’t enrolled in Medicare.
• You can’t be claimed as a dependent on someone else’s tax return. 

In addition, HSA eligibility uses the IRS’ “last-month rule.” This means that you are considered an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year, which is December 1 for most taxpayers.

As defined by the IRS, common qualified medical expenses include:⁵

• Dental treatment.
• Doctor’s office visits and copays.
• Surgery, except cosmetic surgery.
• Eye exams and eyeglasses.
• Flu shots.
• Physical therapy.
• Drug prescriptions. 

The recently passed CARES Act expanded the list of qualifying expenses even further, to include things like telemedicine and over-the-counter drugs, among others. When in doubt, contact your HSA provider to ensure you don’t trigger penalties for unauthorized purchases.

HSAs have a few key benefits that make them unique savings vehicles:

• Pre-taxed contributions. Contributions are usually pre-tax direct deposits from your paycheck. This increases the amount of money that gets deposited and lowers your adjusted gross income, thereby reducing the amount of income taxes you’ll pay each year.
• Tax-free withdrawal. You can withdraw funds tax-free to pay for qualified medical costs at any time. Withdrawals for other reasons will be penalized if you’re under 65.
• Employer match. Some employers will match your contribution. If your employer does, those contributions are also tax-free.
• Unused funds accumulate. Because HSAs are not a “use-it-or-lose-it” type of account, many people build up their balances from year to year. In 2019, there were $60 billion in assets in HSAs, 20% more than the year before.⁶
• Balances are portable. If you switch jobs, change health plan providers, or leave the workforce, you can transfer your balance into another HSA. But you must have an eligible HDHP to keep making contributions.
• Funds can be invested. HSAs typically let you invest your funds so you can earn tax-free returns – making them a good option for long-term savings, too. 

Since many HSA benefits are related to taxes, you may want to check with your personal tax advisor to best understand if they’re right for you.

Most experts agree that the advantages of HSAs outweigh the disadvantages for most people. The most noted disadvantages include:

• Needing an HDHP. By its nature, an HDHP means you will pay more medical expenses out-of-pocket until that high deductible is met. This may create a cash flow crunch even after considering an HDHP’s lower monthly premiums. Withdrawing funds from your HSA can ease that cash crunch, but only up to the amount that is in the account – you can’t “go negative” or borrow against future contributions.
• Contribution limits. Those who anticipate large medical bills can see the annual contribution limits as a disadvantage, as do those who view their HSA as a long-term savings account.
• HSA fees. Trustees who manage HSAs generally charge a fee for their services, which may reduce your earnings. But these fees tend to be small and are often waived if the account maintains a minimum balance, and it’s common for employers to foot the bill.
• Paperwork requirements. Some HSA holders see paperwork requirements as a burden. You’ll be required to submit receipts for qualifying expenses to your HSA administrator, and there are a variety of additional forms you’ll need to attach to your tax return depending on your activity for the year.

Similar to other tax-advantaged accounts, like IRAs and 401(k)s, HSAs also can be a stand-in for regular personal savings accounts. Typically, funds are only withdrawn tax-free for medical expenses, but you can access your balance for other purposes by paying a 20% penalty to the IRS if you are younger than age 65.⁷ 

After age 65, you can access your HSA funds without penalty for anything, not just medical expenses. You will, of course, pay income tax on the withdrawals – since you didn’t pay tax when you originally earned the money – similar to IRA and 401(k) withdrawals. Chances are, you’ll also be in a lower tax bracket at that time.

For many people, HSAs are a useful tool to help manage medical costs. They can also be a good option for tax-advantaged long-term saving. When determining if opening an HSA is right for you, it’s important to carefully consider the rules and eligibility requirements.