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Understanding Health Savings Accounts (HSAs) and How They Work

A Health Savings Account (HSA) is a special type of savings account that allows you to set aside money for qualified medical expenses while receiving tax benefits. Unlike regular savings accounts, contributions to an HSA may reduce your taxable income, and the money you withdraw for eligible medical costs is not taxed. This makes HSAs potentially valuable for managing healthcare costs over time.

HSAs have been available since 2003 and are offered through employers, banks, and financial institutions. According to the Employee Benefit Research Institute, approximately 30 million Americans had HSA coverage as of 2022. The account works by allowing you to contribute pre-tax dollars (money taken from your paycheck before taxes are calculated) up to annual limits set by the IRS. For 2024, individuals can contribute up to $4,150 per year, and families can contribute up to $8,300 per year.

One of the key features of an HSA is that unused money rolls over from year to year. Unlike Flexible Spending Accounts (FSAs), which typically follow a "use it or lose it" rule, HSA balances accumulate. This means if you contribute $3,000 in one year and only spend $1,500 on medical expenses, the remaining $1,500 stays in your account for future use. Over time, this can build into a substantial healthcare fund.

HSAs must be paired with a High Deductible Health Plan (HDHP). An HDHP is an insurance plan with higher out-of-pocket costs but typically lower premiums. For 2024, the IRS defines an HDHP as having a deductible of at least $1,600 for individuals or $3,200 for families, with out-of-pocket maximums of $8,050 for individuals and $16,100 for families.

Practical takeaway: An HSA is a tax-advantaged account designed for people enrolled in HDHPs. The money you contribute reduces your taxable income, and you can use it for qualified medical expenses without paying taxes on those withdrawals. Unlike other healthcare savings accounts, unused HSA funds roll over annually, allowing you to build a medical savings fund over time.

What Qualifies as an HSA-Compatible Health Plan

Not every health insurance plan works with an HSA. Your insurance must meet specific requirements to be considered HSA-compatible. The most important requirement is that your plan must be classified as a High Deductible Health Plan (HDHP) by the IRS. This means the plan has a higher deductible—the amount you must pay out of pocket before insurance starts paying—but typically charges lower monthly premiums.

For 2024, the IRS minimum deductibles are $1,600 for self-only coverage and $3,200 for family coverage. The maximum out-of-pocket limits (the total amount you could pay in a year for covered services) are $8,050 for individuals and $16,100 for families. Some plans have higher deductibles and out-of-pocket limits, but they cannot go below these IRS minimums to be HSA-compatible.

A critical rule about HSA eligibility is that you cannot have other health coverage at the same time. This means you cannot be covered by a spouse's traditional health insurance plan, Medicare, Medicaid, or TRICARE (military insurance) and also contribute to an HSA. You also cannot have coverage through a Flexible Spending Account (FSA) that covers medical expenses, though limited-purpose FSAs and dependent care FSAs are allowed alongside HSAs.

HSA-compatible plans come from various sources: employer-sponsored coverage, the Health Insurance Marketplace (Healthcare.gov or state exchanges), or individual plans purchased directly from insurance companies. Some employers offer HDHP options during their annual open enrollment periods. If you do not have employer coverage, you can research plans available in your area through the Health Insurance Marketplace.

Many states and insurance companies offer multiple HDHP options with different deductible levels and premium costs. A plan with a lower deductible typically costs more in monthly premiums, while a plan with a higher deductible costs less monthly but requires you to pay more out of pocket before coverage begins.

Practical takeaway: To open an HSA, you must be enrolled in an HDHP with a deductible of at least $1,600 for individuals or $3,200 for families. You cannot have other health coverage (such as Medicare or a spouse's traditional plan) at the same time. Review your current insurance to confirm whether it meets HDHP requirements, or compare HDHP options through your employer or the Health Insurance Marketplace.

Income Limits and Tax Considerations

Unlike some healthcare programs, HSAs do not have income limits that prevent higher earners from opening an account. Anyone with an HDHP can open and contribute to an HSA regardless of how much money they make. This makes HSAs available to a broad range of workers and self-employed individuals.

However, income does matter when calculating your federal income taxes. The money you contribute to an HSA reduces your taxable income, which can lower the amount of income tax you owe. This tax benefit is one of the main reasons HSAs are considered valuable financial tools. For example, if you earn $50,000 and contribute $2,500 to an HSA, your taxable income is reduced to $47,500, potentially lowering your overall tax bill.

If your employer contributes to your HSA on your behalf, that contribution also does not count as taxable income to you. Many employers contribute to employee HSAs as part of their benefits package. The IRS sets annual contribution limits: $4,150 for individuals and $8,300 for families in 2024. If you are age 55 or older, you can contribute an additional $1,000 per year (called a catch-up contribution). These limits can change annually based on inflation.

It is important to track your HSA contributions carefully because exceeding the annual limit results in taxes and penalties on the excess amount. If you contribute too much, the IRS charges a 6 percent excise tax on the overage each year until it is removed. Additionally, your HSA statements should be saved for tax purposes, as you may need them if you are audited.

The money in your HSA grows tax-free if it remains invested in the account. Some HSA accounts offer investment options similar to retirement accounts, allowing your balance to potentially grow beyond what you contribute. Any earnings on invested HSA funds are not taxed as long as the money is used for qualified medical expenses.

Practical takeaway: HSAs have no income limits, meaning anyone with an HDHP can open one. Your contributions reduce your taxable income, potentially lowering your taxes. The annual contribution limits are $4,150 for individuals and $8,300 for families in 2024. Keep records of your contributions and withdrawals for tax documentation, and do not exceed the annual limit.

Types of Medical Expenses You Can Pay With HSA Funds

One of the valuable features of an HSA is that you can use the funds to pay for a wide range of qualified medical expenses. The IRS defines qualified medical expenses as costs for diagnosis, cure, treatment, or prevention of disease, as well as treatments affecting the structure or function of the body. This includes more than just doctor visits and prescription medications.

Common qualified expenses include doctor visit copays and deductibles, prescription medications, dental work (fillings, root canals, extractions, and dentures), vision care (eye exams, glasses, and contact lenses), hearing aids and hearing aid batteries, mental health counseling and psychiatric care, physical therapy and rehabilitation, laboratory fees and diagnostic tests, and hospital stays. You can also use HSA funds to pay for over-the-counter medications like pain relievers, cold medicines, and allergy medications, though you may need to provide a prescription from your doctor to do so.

Some less obvious qualified expenses include acupuncture, chiropractic treatment, organ transplants, surgery recovery equipment, guide dogs for the blind, and home modifications made for medical reasons (such as installing grab bars or wheelchair ramps). Long-term care insurance premiums may also be paid with HSA funds, with certain limits based on age. Additionally, you can use HSA funds to pay for family members' qualified medical expenses, not just your own.

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