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What Is an HSA and How Does It Work

A Health Savings Account (HSA) is a special savings account that lets you set aside money specifically for medical expenses. Unlike a regular bank account, an HSA has tax advantages that can help your healthcare dollars go further. When you put money into an HSA, you don't pay federal income taxes on that money. When you use the money to pay for medical care, you also don't pay taxes on those withdrawals. This double tax break makes HSAs different from other ways to save.

The account works by letting you contribute money throughout the year, up to annual limits set by the government. For 2024, individuals can contribute up to $4,150 per year, while families can contribute up to $8,300 per year. These limits change each year based on inflation. The money you put in stays in your account and can be invested, meaning it may grow over time. You can use HSA money to pay for a wide range of medical expenses, including doctor visits, prescription medications, dental care, vision care, and medical equipment.

One powerful feature of HSAs is that unused money rolls over year to year. Unlike some other savings programs, you don't lose money you don't spend in a given year. This means an HSA can become a long-term savings tool for healthcare costs as you age. After age 65, you can withdraw money for any reason without penalty (though non-medical withdrawals may be taxed like regular income). This flexibility makes HSAs valuable for retirement planning.

However, HSAs have requirements. You must be covered by a high-deductible health plan (HDHP) to open and contribute to an HSA. You cannot have other health coverage that isn't an HDHP, and you cannot be claimed as a dependent on someone else's tax return. Understanding these basic rules helps you determine whether an HSA fits your situation.

Practical Takeaway: An HSA is a tax-advantaged savings account for medical expenses that lets money grow year to year. Before exploring further, check whether you have or could get a high-deductible health plan, since that's the main requirement for HSA participation.

Understanding High-Deductible Health Plans (HDHPs)

To open an HSA, you must be enrolled in a high-deductible health plan. An HDHP is a type of health insurance that has lower monthly premiums but higher deductibles compared to traditional health plans. The deductible is the amount you must pay out of your own pocket for medical care before your insurance starts to share costs with you. For 2024, an HDHP for an individual must have a deductible of at least $1,600, and for families, at least $3,200.

HDHPs appeal to many people because of the lower monthly payments. If you're generally healthy and don't expect frequent doctor visits, an HDHP can cost less overall than a traditional plan. The money you save on premiums can go into your HSA, creating a reserve for medical costs that do arise. However, if you have chronic health conditions or anticipate significant medical expenses, an HDHP might mean paying more out of pocket before insurance coverage kicks in.

An important protection within HDHPs is the out-of-pocket maximum. Even though you have a higher deductible, there's a limit to how much you'll pay in a year. For 2024, the maximum out-of-pocket cost for an individual in an HDHP is $8,050, and for families, $16,100. Once you reach this limit, your insurance covers the remaining healthcare costs at 100%. This cap protects you from catastrophic medical bills.

Many people choose HDHPs through their employer, but they're also available on the individual market through healthcare.gov or state-run marketplaces. When shopping for an HDHP, compare the monthly premium, the deductible amount, the out-of-pocket maximum, and which doctors and hospitals are in the plan's network. Some HDHPs offer preventive care (like annual checkups and vaccinations) before you meet the deductible, which can add value.

Practical Takeaway: An HDHP is required to open an HSA. If you're considering an HSA, examine whether an HDHP option exists where you get insurance—through your employer, the marketplace, or a private insurer. Look at the deductible, monthly premium, and out-of-pocket maximum to see if the plan's structure matches your healthcare needs.

How to Open and Fund Your HSA

Once you have or are enrolling in an HDHP, you can open an HSA. Many employers offer HSAs as part of their benefits package, and if yours does, they often handle much of the setup. If your employer offers an HSA, you typically enroll during the open enrollment period or when you first become part-time or full-time staff. Money you contribute through payroll deductions goes into the account before taxes are taken out, maximizing your tax savings.

If your employer doesn't offer an HSA, you can open one independently through a bank, credit union, brokerage firm, or insurance company. Common institutions offering individual HSAs include Fidelity, Lively, Optum Bank, and regional banks. To open an account, you'll need to provide personal information, verify that you have an HDHP, and choose whether you want the account to work like a savings account or whether you want to invest the money in stocks and bonds. Many people keep a portion in savings for immediate medical needs and invest the rest for long-term growth.

You can fund your HSA in several ways. The most common is through payroll deductions if your employer offers it. Self-employed people and those without employer HSA programs can contribute on their own, either through bank transfers, checks, or electronic payments. Annual contribution limits apply—$4,150 for individuals and $8,300 for families in 2024. If you're 55 or older, you can contribute an additional $1,000 per year (called a "catch-up contribution"). Contributions can be made until the tax filing deadline the following year, typically April 15.

When you open an HSA, you'll receive a debit card or checkbook that lets you pay for medical expenses directly from the account. You can also pay for medical care out of pocket and then reimburse yourself from your HSA later. Many people save receipts and reimburse themselves years later, allowing the account to grow tax-free in the meantime. This strategy turns the HSA into a powerful retirement savings vehicle.

Practical Takeaway: Opening an HSA involves either enrolling through your employer's benefits program or selecting a financial institution to open an individual account. You then fund it throughout the year up to annual limits. Keep records of what you contribute to make sure you stay within legal limits.

Qualified Medical Expenses You Can Pay For

HSA money can be used to pay for a long list of medical expenses. The key rule is that the expense must be for diagnosis, treatment, or prevention of a medical condition, and it cannot be something that's merely beneficial to your general health. The IRS publishes detailed guidance on what counts. Common qualified expenses include doctor and dentist visits, hospital stays, prescription medications, and medical equipment like crutches or wheelchairs.

Vision and dental care are major categories covered by HSAs. You can pay for eye exams, glasses, contact lenses, and vision correction surgery like LASIK. Dental expenses include cleanings, fillings, root canals, and orthodontia. Mental health treatment, including therapy and psychiatric medications, is also covered. Hearing aids and cochlear implants, along with related services, are qualified expenses. Physical therapy, chiropractic care, and acupuncture may be covered depending on your situation and whether they're prescribed for a medical condition.

Over-the-counter medications require special attention. As of 2020, you can use HSA funds to buy most over-the-counter medications without a prescription, including pain relievers, allergy medications, cold remedies, and antacids. However, products like vitamins and supplements that aren't treating a specific medical condition are generally not covered. Menstrual care products, including tampons and pads, became qualified expenses starting in 2020.

Expenses that do NOT count include cosmetic procedures (unless treating a disfigurement from injury or disease), general wellness products, gym memberships, and most over-the-counter items used for general