The popularity of health savings accounts (HSAs) has surged dramatically in recent years. According to a report by Devenir1, an HSA investment consultant, consumers had about 32 million total HSAs by the end of 2021, surpassing $100 billion in savings. The firm forecasts HSA funds will hit $150 billion by 2024.
But what are HSAs, and why are they becoming popular? In this article, we'll go over what HSAs are, how they work, and answer some frequently asked questions about them.
What is an HSA?
A health savings account (HSA) is a flexible savings plan that allows you to save pre-tax dollars from your paycheck in an account that earns interest. You can use the funds to pay for qualified medical expenses, such as doctor visits, prescription drugs, diagnostic services, dental care, vision care, and over-the-counter medications.
With an HSA, you can withdraw funds tax-free or reimburse yourself for qualified healthcare expenses or defer taking such reimbursements indefinitely without penalties.
HSAs have unique benefits with triple tax saving advantages, including:
- Employee and employer contributions are tax-deductible
- Tax-free accumulation of interest and dividends
- Tax-free distributions for qualified medical expenses
How does an HSA work?
Your HSA contributions are deposited into a savings account that allows you to earn interest on your healthcare dollars. These contributions are FDIC-insured and tax-free. Both you and your employer can choose to contribute to your HSA.
Generally, you use your HSA funds to pay for qualified medical expenses up to your individual or group health insurance deductible. Once you reach the deductible, your health plan coverage begins.
Your HSA provider usually issues you a debit card. When you use your HSA debit card to cover your medical services, the payments are automatically withdrawn from your account. Unused funds remain in your HSA until you use them.
How do HSAs help you save money?
You reduce your total annual taxable income as you deposit funds into your HSA. All funds withdrawn from your HSA for a qualified medical expense are tax-advantaged.
Am I eligible for an HSA?
Many factors determine HSA eligibility. To open an HSA, you need a qualified high-deductible health plan (HDHP). This can be an HDHP you purchase on your own or get through your employer's group health insurance plan.
HDHPs typically have a higher annual deductible than traditional health plans. For 2023, an HDHP is any health plan with a minimum deductible of $1,500 for individuals and $2,800 for families. There is a maximum annual deductible and out-of-pocket expenses cap of $7,500 for self-only coverage and $15,000 for family coverage.
To qualify for an HSA:
- You must be covered under an HDHP on the first day of the month you are contributing to an HSA
- You have no other health coverage except what is permitted in IRS Publication 9692
- You aren't enrolled in Medicare
- Nobody can claim you as a dependent on their tax return for the year
How much can I contribute to my HSA?
Investing in an HSA makes it easier to handle the current and future expenses related to your health and well-being. You can make direct contributions to your HSA at any time, but there are annual limits to how much you can contribute.
Catch-up contributions are available to those age 50 or older to help make up for the years you might not have contributed to an HSA when you were younger. Your catch-up amount is an additional contribution that's separate from the annual contribution limits for an HSA.
The IRS adjusts the maximum contribution limits guidelines for HDHPs and HSAs each year.
For 2023, the maximum limits are as follows:
HSA contribution limit
HSA catch up contribution
If you go over the annual contribution limit, you could end up with excess funds. This means you would have to pay a 6% excise tax on the excess contribution if you didn’t withdraw the amount from your HSA before the tax filing deadline. In addition to the excise tax, the additional funds would be considered taxable income and can't be counted as a tax deduction for contribution when you file.
What expenses can an HSA be used for?
You may spend the HSA money tax-free on out-of-pocket expenses, such as deductibles, copays for medical care, prescription drugs, or bills not covered by insurance, such as dental and vision care expenses.
The IRS determines the types of medical expenses you can use tax-free with HSA funds. They are listed in IRS Publication 502.
If you use HSA funds for non-medical expenses before age 65, you must pay taxes on the withdrawal plus a 20% penalty.
After age 65, you can use your HSA funds for non-medical expenses without an additional tax penalty. You'll only need to pay standard income taxes on that amount.
Can I use my HSA for my spouse if they are not on my plan?
Yes, you can use your HSA for your spouse or eligible dependents, even if they aren't on your insurance plan.
You can use your HSA to pay for qualified medical expenses for your spouse and any qualified dependents if you claim them on your income tax return. However, paying for your spouse’s or dependents’ medical care with your HSA doesn’t mean you can contribute more to your HSA. The family contribution limit only applies if your spouse also has an HSA.
Do HSA funds expire?
No. Unlike with a flexible spending account (FSA), you don't have to use HSA funds by the end of the year. Any unused funds in your HSA roll over from year to year, and rollover contributions don't reduce your overall contribution limit for the year. Plus, your healthcare dollars will grow tax-deferred in your HSA for later use.
How do I invest my HSA money?
HSA administrators typically offer accounts that are easy to access for medical expenses. Many HSA administrators or banks will let you shift money into mutual funds and other investments after your HSA account balance reaches a certain level. These can vary by your HSA provider.
Investment options for HSAs include mutual funds, exchange-traded funds (ETFs), stocks, and bonds. You can't invest in collectibles, art, automobiles, or real estate with an HSA. A tax advisor can help you find the best way to maximize your savings.
Can I contribute to my HSA account after age 65?
You must not enroll in Medicare Part A or Medicare Part B to contribute to an HSA after age 65. You can enroll in Medicare Part A by filing an application or being approved automatically. The Social Security Administration also automatically enrolls you in Part A when you start collecting Social Security benefits.
Many people who work for smaller organizations with fewer than 20 employees will have Medicare as their primary insurance at age 65.
If you avoid enrolling in Medicare or taking Social Security benefits yet, you can continue contributing to an HSA and participating in catch-up contributions after age 65.
Do the HSA tax benefits phase out at certain income levels?
No, there’s no income limit with an HSA.
If I set up an HSA through my employer, what happens if I switch jobs?
If you set up an HSA through your employer and switch jobs, you can keep the money after you leave. There is no requirement to spend your HSA balance before you terminate employment.
To contribute to your HSA, you need HDHP coverage. However, your HSA belongs to you. You'll always be able to use your funds for qualified expenses.
Can I cash out my HSA when I leave my job?
Yes, you can cash out your HSA at any time. However, any funds withdrawn for costs other than qualified medical expenses will result in the IRS imposing a 20% tax penalty.
If you leave your job, you don't have to cash out your HSA. You can continue to contribute to your HSA if you have an HDHP, even after leaving your job.
What happens if I change insurance?
As long as you have a qualified HDHP, you can continue contributing to your HSA. Most HSAs can be transferred.
If you are no longer covered by an HDHP, you still have access to your unused funds, but you won't be able to make any additional contributions to your HSA.
How does health reform change HSAs?
Recent health reform bills have changed how HSAs operate. The Affordable Care Act (ACA) was signed into law in 2010 and significantly changed HSAs.
The ACA made two changes to HSAs:
- Over-the-counter medications were no longer eligible for tax-free withdrawals unless obtained with a prescription (except for insulin)
- The excise tax for non-qualified HSA withdrawals increased from 10% to 20%
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which passed on March 27, 2020, restored the ability to use HSAs to purchase certain over-the-counter drugs and medications, like allergy medication, aspirin, and other pain medications without a prescription. The CARES Act was also the first to classify menstrual care products as eligible expenses.
Can you have an HSA and an HRA at the same time?
Yes, you can have an HSA and a health reimbursement arrangement (HRA) simultaneously as long as your HRA is considered “HSA-qualified.” There are many ways to adjust HRAs to make them HSA-qualified, but the simplest is using a limited-purpose HRA.
In years where you want to contribute to an HSA, you can only use your HRA to reimburse the following expenses:
- Health insurance premiums for coverage
- Wellness/preventative medical care (e.g., checkups, mammograms, smoking cessation, weight loss, etc.)
- Dental expenses
- Vision expenses
- Long-term care premiums
What is the difference between an HRA, HSA, and FSA?
HRAs, HSAs, and FSAs are types of health benefits available to you. However, they each work differently.
An HSA is a savings account used in conjunction with a high-deductible health plan (HDHP) that allows you to save money tax-free for medical expenses. HSAs can be used for non-medical expenses, but they will be subject to a tax penalty until age 65.
You and your employer can contribute to your HSA.
HRAs are employer-funded and tax-advantaged health benefits used to reimburse employees for qualifying medical expenses. These include individual health insurance premiums and out-of-pocket medical costs.
An HRA is often offered in place of traditional group health insurance so that employees can purchase their own individual health insurance plans that best fit their unique needs. However, an integrated HRA can be paired with a group health insurance plan like an HDHP to extend coverage for employees.
Three of the most popular types of HRAs are:
- Qualified small employer HRA (QSEHRA) - Designed for organizations with fewer than 50 full-time equivalent employees (FTEs)
- Individual coverage HRA (ICHRA) - Great for organizations of all sizes who want to customize their employee classes and benefit allowance amounts
- Group coverage HRA (GCHRA) - Also known as an integrated HRA, a GCHRA is used to supplement a group health insurance policy
A health FSA is a special account offered to employees by their employers. Employers put money into an account tax-free for certain out-of-pocket medical costs with a healthcare FSA. Employees submit expense claims to their employer with a statement that their health insurance plan doesn't cover the expense. Then, employers reimburse employees for their eligible expenses.
FSA funds generally expire3 after the benefit year, but your employer can establish a grace period or allow up to $570 per year to carry over.
What's the difference between an HSA and a health stipend?
A health stipend is a taxable sum of money offered to employees for their medical expenses. This can be a benefits card, a lifestyle spending account (LSA), or a reimbursement method similar to an HRA.
Health stipends are offered to employees by their employers, and there aren't any contribution limits. Employers generally provide a monthly allowance and choose which types of medical expenses are eligible.
HSAs are growing in popularity for good reasons. Alongside an HDHP, they're an excellent tax-advantaged way to reduce your total healthcare cost. You can use the money in your HSA to pay for qualified medical expenses like doctor visits, prescription drugs, dental care, vision care, and over-the-counter medications. Plus, if you don't use all of your HSA funds, they'll roll over from year to year and earn more interest. Having this type of nest egg makes it easier to handle the unexpected curveballs life throws your way.
This blog article was originally published on August 12, 2013. It was last updated on May 4, 2023.