What Is an HSA?

Even with great health insurance, the cost of health care can be surprising. One way to help cover those costs and help save money? A health savings account (HSA).

An HSA is a tax-advantaged savings account designed to be used for qualified medical expenses. It can help you save for medical expenses while reducing your taxable income. Learn more about HSAs, including how they work, the advantages and disadvantages, and how to set one up.

How does an HSA work?

An HSA works in combination with a high-deductible health plan (HDHP) to cover out-of-pocket medical costs. However, not all HDHPs are HSA qualified. According to the Internal Revenue Service (IRS), a qualifying HDHP for 2023 is defined as having a deductible of at least $1,500 for self-only coverage or $3,000 for family coverage.¹ A qualifying HDHP must also limit the annual out-of-pocket maximums to $7,500 for self-only coverage and $15,000 for family coverage.¹

If you're enrolled in an eligible HDHP, you can make pretax dollar contributions to an HSA, as can your employer, spouse, and family members. For 2023, health contribution limits are $3,850 for individuals and $7,750 for families.¹

Employers who offer HDHPs may also offer HSAs. If your employer doesn’t offer HSAs, you can purchase a plan on your own. Self-employed and unemployed individuals can also contribute to an HSA, as long as they meet eligibility requirements.

HSA eligibility

To be eligible for an HSA, you must be enrolled in an HSA-compatible HDHP. In addition, you’ll need to meet the following requirements to contribute to an HSA:

• You aren’t covered under any other health plan that’s not a qualified HDHP — including a general purpose health care flexible spending account (FSA) or health reimbursement account (HRA) — or if you aren’t covered under TRICARE.
  
• You aren’t enrolled in Medicare or Medicaid.
  
• You can’t be claimed as a dependent on another person’s tax return.

HSA eligible expenses

• Birth control
  
• Childcare
• Hearing aids
• Chiropractor
• Contact lenses
• Acupuncture
• Weight-loss programs
• Dental treatment
• Prescription eyeglasses
• Therapy
• Lab work
• Medical supplies
• Physical exams
• Prescriptions
• Radiology
• Ambulance costs
• Smoking cessation programs
• Surgery (non-cosmetic)
• X-rays
• Long-term care services

For a complete list of eligible expenses, review Publication 502, Medical and Dental Expenses from the IRS.

HSA: Benefits and limitations

There are several benefits of having an HSA, like a triple tax advantage – you contribute pre-tax dollars, pay no taxes on any interest or earnings, and can withdraw the money tax-free.  But there are also a few limitations, including strict eligibility requirements and potentially steep financial ramifications.

Consider the following before opening an HSA:

Benefits

Contributions aren’t subject to tax: The money you put into an HSA is excluded from your taxable income, as are any contributions made by an employer. Participants can also contribute post-tax money and claim a tax deduction after they file.

Money can be invested to grow tax-free: The money in your account can be used to invest in stocks, mutual funds, and other securities. Any interest or other returns earned will not be taxed and can be used to maximize growth.

Withdrawals aren’t subject to tax: As long as you use the money in your account for qualified medical expenses, withdrawals will not be taxed.

Balances automatically roll over to the next year: HSAs aren’t subject to any “use-it-or-lose-it” mandates. This means the money in your account doesn't expire, and any leftover money can be used the following year.

Accounts are owned by an individual, not an employer: The money saved in an HSA is yours. So even if you change employers or retire, you can keep your HSA.

Money may be used for spouses and dependents: In some cases, you can use the money in your HSA for a spouse or dependent(s) — as long as the money is used to pay for qualified medical costs.

Limitations

Must be able to afford deductibles of an HDHP: To have an HSA, you’ll need to be enrolled in an HDHP. An HDHP will require you to have the financial resources to cover deductibles before your insurance coverage kicks in.

There are maximum contribution limits: Both individual and employer contributions are limited to a maximum annual amount. The IRS updates contribution limits each year.

Money used for non-medical expenses will be taxed and penalized: Any withdrawals not used for qualified medical expenses are subject to income tax and a 20% tax penalty if you’re under 65.³

HSA vs. FSA

A flexible spending account (FSA) is similar to an HSA. Both are tax-advantaged savings accounts intended to be used for medical expenses, but there are some significant differences between an HSA and FSA.

Here are some key differences between them:

• FSAs are owned by an employer, not an individual.
• FSAs must be set up by an employer (self-employed or unemployed individuals aren’t eligible).
• Funds in an FSA typically need to be used by the end of the year, or you lose them.
• Money in an FSA can’t be invested or earn interest.
• Money in an FSA doesn’t go with you if you change employers.

How to start an HSA account

If you’re interested in starting an HSA, and you meet all the requirements, check with your employer to see if they offer one as part of your employee benefits. If not, you can open an account on your own with an HSA provider. Some financial institutions also offer HSAs.

Is an HSA right for me?

An HSA may not be right for everyone. To determine if you should open an HSA, consider your specific circumstances. It’s important to consider your needs, like if you have a lot of medical expenses or want to save on future healthcare costs and if you have the financial ability to cover deductibles and contributions.

In addition to an HSA, you may want to consider getting supplemental health insurance, a limited purpose flexible spending account (LPFSA), or an emergency fund to help cover medical expenses.