Key takeaways
- Health savings accounts (HSA) can help offset eligible health care expenses while lowering taxes.
- You may be able to invest the money that’s in your account.
- You can pass your HSA money on to your heirs.
What is a Health Savings Account?
A health savings account (HSA) is a tax-advantaged way to stash away money to cover eligible health care expenses. Often, employees can open an HSA in conjunction with a high-deductible health plan (HDHP) at work. This employee benefit can be beneficial now and in retirement.
How does an HSA work?
Employees and employers can contribute to an HSA. For 2023, the combined contribution limits (employee plus employer) are $3,850 for an individual and $7,750 for family accounts (for 2024, the limits are $4,150 for individuals and $8,300 for families). If you’ll be at least 55 by the end of the year, you can make an additional “catch-up” contribution of up to $1,000.
HSA vs. FSA
HSAs are sometimes confused with another type of account called a Flexible Spending Account or FSA. These accounts cover the same expenses, but they work differently.
A health FSA allows you to pay for qualified medical expenses not covered by insurance with pre-tax dollars. However, FSAs are only offered through an employer, so if your employer doesn’t offer an FSA, you’re out of luck.
Here’s a look at some of the other differences between these accounts:
| HSA | FSA | |
|---|---|---|
| Individual contribution limits for 2023 | $3,850 | $3,050 |
| Deadline to use money | No deadline | December 31 of the plan year or March 15 if your plan offers a grace period. Any money not spent by that date is forfeited unless that plan allows a rollover up to IRS limits. Plans typically cannot offer both a grace period and rollover |
| Tax-free growth? | Yes | No |
Is an HSA tax deductible?
An HSA is tax deductible, while money put into an FSA is pre-tax. Your HSA contributions lower your federal taxable income and, in most cases, your state taxable income too. (Note that deductions don’t cut your taxes dollar for dollar; instead, when you put in $1,000, if you’re in a 25% tax bracket, you would save 25% of $1,000, or $250 off your taxes. People in higher tax brackets save even more.) Money your employer contributes is usually tax-free.
Tax implications for the future
When you (or your spouse or dependents) incur eligible medical expenses, you can withdraw money from your HSA tax-free to pay for them, either directly via an account-linked debit card or by being reimbursed from your account. (This is different from, say, a traditional 401(k) or IRA, where you contribute pretax or tax-deductible dollars but owe tax when you withdraw.) In general, you can use HSA funds toward medical, dental, vision, and prescription drug expenses, including copays, deductibles, and coinsurance.
Also, because there’s no limit on when you can tap your account, HSAs are attractive for retirement planning. Indeed, with an HSA, you could incur an expense now and get reimbursed for it 10 years from now (as long as you have proof of the expense).
This means you may not have to use taxable withdrawals from your “retirement” account for medical expenses. In fact, it amounts to free health care in your golden years.
Tax implications for investing
You may be able to invest some or all of your HSA funds, just like you can for an IRA. Your HSA investments can grow tax-free. This results in triple tax savings: You save on taxes once when you contribute, again on your potential investment growth, and finally when you withdraw the funds to pay for eligible medical expenses.
Using an HSA with Medicare
When you enroll in Medicare, you must stop contributing to your HSA. However, you can still withdraw money from your account, tax-free, for qualified medical expenses that Medicare doesn’t cover.
If you reach retirement age and are still working, you can delay your Medicare enrollment so you can continue to contribute to your HSA. However, you also will have to delay collecting Social Security benefits, because once you start taking those, you automatically enroll in Medicare. (You can’t decline your Medicare Part A benefits while you are collecting Social Security benefits.)
Penalties and tax liabilities
Stop contributing to your health savings account six months before you enroll in Medicare, which covers you retroactively for those six months. (You could be subject to taxes.)
Also, if you withdraw HSA funds for nonmedical expenses before you turn 65, you will owe income tax on the withdrawal and an additional 20% penalty. (If you do so after age 65, you’ll avoid the penalty but will still owe income tax on the withdrawal.)
What happens to your HSA if you die
You can pass your HSA money on to your heirs. How it’s taxed depends on the beneficiary (spouse vs. non-spouse).
Other health plans you can have at work
You can’t have other health care coverage when you enroll in a high-deductible health plan with an HSA, with these exceptions:
- You can carry coverage for a specified illness.
- You can have coverage that pays a set amount per day of hospitalization.
- You can have coverage for accidents, disability, dental and vision care, and long-term care.
- You can have coverage for Workers’ Compensation liabilities, or property ownership liabilities.
Also keep in mind that if you contribute to an HSA, you can’t fund a health care flexible spending account (FSA). Even so, you may be able to contribute to a “limited purpose” FSA that covers only dental and vision expenses.
Reporting on your tax return
If you contribute to a health savings account or withdraw money from one, you may need to report it on IRS Form 8889 when you file your federal income taxes. You may also need to keep proof of the expenses covered by HSA money in case you get audited.
What you can do next
Get the facts where you work: Check to see if you’re eligible for an HSA and ask whether your employer contributes to the account. This amounts to free money for you.
Check with your tax advisor or read IRS Publication 969 (Health Savings Accounts and Other Tax-Favored Health Plans) for more information.
Please consult your tax advisor concerning your particular circumstances.
Kevin Johnston writes about personal finance and investments, as well as financial management and planning. He has written for The New York Daily News, The New York Post, The San Francisco Chronicle and The Houston Chronicle.
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