Health Savings Accounts (HSAs) allow anyone with a qualified high-deductible health plan to set aside pre-tax money to pay for approved medical expenses. The funds are held by the HSA’s trustee (a bank, credit union, or other financial institution) until they are withdrawn to pay for specific medical expenses.
Although medical savings accounts have a variety of benefits, there are also significant drawbacks to consider.
Health savings account basics
Consumers enrolled in qualified high-deductible health plans (HDHPs) are most likely to use health savings accounts.
The 2024 HSA contribution limits are $4,150 for individuals and $8,300 for families. Employees who reach age 55 by the end of the tax year may contribute an additional $1,000 as a supplemental provision.
When HSA contributions are deducted from your paycheck, your taxable income is reduced by the amount of your contributions. Interest earned on HSA accounts is also not taxable. If you have sufficient account balances, most trustees will allow you to invest your HSA funds in mutual funds, bonds, or stocks.
Health Savings Account Benefits
There are several benefits to opening a health savings account.
- Donations are pre-tax: When you contribute to an HSA through payroll deduction, the funds are pre-tax. Your employer, relative, or anyone else can donate, and those funds are also tax-free.
- Withdrawals are not taxed: Withdrawals are not taxable as long as the money is used to pay for qualified medical expenses.
- federal tax credit: If you’re not working, you can continue to contribute to your HSA and deduct it on your federal tax return.
- No non-medical penalties after age 65: Once you turn 65, funds used to pay for non-medical expenses are taxable, but there is no 20% tax penalty.
- No opening deposit: There is typically no minimum deposit required to open an HSA account.
- If the balance is carried forward: Unlike Flexible Spending Accounts (FSAs), which must be used by the end of the plan year, HSA balances roll over. There is no time limit on the use of funds.
- Investment opportunities: With an HSA, you can invest your funds in stocks, bonds, and other products. Earnings are tax-free. Some trustees require a certain minimum balance before allowing you to invest.
- Portability: HSAs are portable. You are the account owner. Even if you quit your job, you can take your HSA with you.
- Insurance coverage: HSAs held at federally insured banks and credit unions are insured up to $250,000.
- Benefits for families: HSA funds can be used to pay for qualified medical expenses for your spouse and dependent children, even if they are not covered by the HDHP.
- Medicare premium offset: After retirement, the funds can be used to pay premiums for Medicare or Medicare Advantage plans (but not Medigap insurance).
- Easy transfer: HSA funds invested in mutual funds or stocks can be transferred to pay for approved medical expenses as needed.
Disadvantages of health savings accounts
It’s important to consider the potential disadvantages of using a health savings account.
- Non-medical fines: Before age 65, HSA funds withdrawn to pay non-medical expenses are considered taxable income. The IRS also imposes a 20% penalty.
- social security fines: If you don’t stop contributing to your HSA six months before you apply for Social Security benefits, tax penalties may apply.
- Not everyone is eligible: If someone else’s tax return claims you as a dependent, you are not eligible for an HSA.
- For those registered with HDHP only: Only people with high-deductible health insurance are eligible for an HSA. Meeting high insurance deductibles can be difficult.
- HSA card rejection: Not all stores accept HSA debit cards, so you may have to pay for your expenses out of pocket and get reimbursed by your HSA trustee.
- Weak returns and investment limitations: Interest rates on HSA accounts can be low, and some trustees charge a monthly fee if your balance falls below a certain threshold. Minimum balance requirements may apply before making an investment. Investment options may be limited and investments are not insured.
- No further contributions: Once an individual reaches age 65 (Medicare eligibility age), they can no longer make additional contributions (including catch-up contributions), even if they are still employed.
Is an HSA right for you?
Savers who want to put money aside for medical expenses may be able to use an HSA or FSA, or both, depending on their employer’s benefit plan. Both have tax benefits, so compare the two accounts before choosing.
HSAs have fewer restrictions and more tax benefits than FSAs. HSA funds roll over and continue to grow, allowing you to benefit during the golden years when many seniors are worried about paying medical expenses not covered by insurance. If your employer doesn’t offer an HSA or you want to pursue your own options, there are many great HSA providers you can consider to find the one that’s best for you.
— Freelance writer ashley tilford Contributed to updating this article. Former bank rates writer Libby Wells wrote an earlier version of this article.
