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What Health Savings Accounts (HSAs) Are and How They Work

A Health Savings Account, or HSA, is a special type of savings account that lets you set aside money specifically for medical expenses while potentially reducing the amount of income taxes you pay. Unlike a regular savings account at a bank, an HSA has tax advantages built in. When you contribute money to an HSA, that money generally is not subject to federal income tax. This means if you put $3,000 into an HSA during a year, you may not have to pay income tax on that $3,000.

To have an HSA, you must be covered by what the IRS calls a "high-deductible health plan" or HDHP. This is a type of health insurance that has lower monthly premiums but a higher deductible than traditional insurance plans. The deductible is the amount you must pay out of your own pocket for healthcare services before your insurance starts to help pay. For 2024, the IRS defines an HDHP as having a deductible of at least $1,600 for individual coverage or $3,200 for family coverage.

One of the main benefits of an HSA is that the money you don't spend in a given year rolls over and stays in the account. This is different from a Flexible Spending Account (FSA), where unused money is typically forfeited at the end of the year. With an HSA, you can let your money grow year after year, making it useful for building savings for future medical costs.

The money in an HSA can be used to pay for a wide range of medical expenses, including doctor visits, prescription medications, dental work, vision care, and mental health services. You can also use HSA funds to pay for certain medical equipment and supplies. The IRS maintains a detailed list of what counts as a qualified medical expense.

Practical Takeaway: An HSA is a tax-advantaged savings tool for people with high-deductible health insurance. Understanding the basic structure—that it requires an HDHP, allows tax-free contributions, and lets you save unused funds—is the first step toward learning whether this account type might fit your situation.

Tax Advantages and How They Reduce Your Tax Burden

The tax benefits of an HSA work in three ways, often called "triple tax advantages" in financial discussions. First, when you contribute money to an HSA, that contribution is generally deductible from your gross income, which means you pay less in federal income taxes. For example, if you earn $50,000 a year and contribute $2,000 to an HSA, your taxable income may be reduced to $48,000. Depending on your tax bracket, this could save you hundreds of dollars in taxes annually.

Second, any earnings that accumulate in your HSA—such as interest if you keep money in a savings portion of the account, or investment gains if you invest HSA funds—are not subject to federal income tax as long as the earnings stay in the account. This means your money has the potential to grow without being taxed along the way. Some HSA providers allow you to invest your balance in mutual funds or other investments, similar to how a retirement account works.

Third, when you withdraw money from your HSA to pay for qualified medical expenses, that withdrawal is not taxable. This means you never pay federal income tax on the money you use for healthcare. By contrast, if you tried to pay for those same medical expenses using money from a regular savings account or checking account, you would use after-tax dollars—money you already paid income tax on.

To understand the cumulative effect, consider this scenario: You earn $60,000 per year and contribute $2,500 to an HSA. You invest that money and earn $200 in returns over time. You then spend $1,200 on dental work and $300 on prescription medications, withdrawing $1,500 from your HSA for these expenses. None of the $2,500 contribution, the $200 in earnings, or the $1,500 withdrawal is subject to federal income tax. If you had used taxable income instead, and assuming you are in the 22% tax bracket, that same $1,500 would have cost you about $1,830 after taxes.

It is important to note that HSA tax benefits apply only to federal income taxes. Depending on where you live, state income taxes may or may not apply to HSA contributions and withdrawals. Additionally, the IRS has specific rules about which expenses count as qualified medical expenses. Using HSA funds for non-qualified expenses typically results in both income tax and a penalty on the withdrawal.

Practical Takeaway: Understanding the three layers of tax benefits—deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses—helps you see the full financial picture of how an HSA might reduce your overall tax liability compared to other savings strategies.

Contribution Limits and How to Calculate What You Can Save

The IRS sets annual contribution limits for HSAs, and these limits change from year to year. For 2024, individuals with self-only coverage can contribute up to $4,150 per year, while families with family coverage can contribute up to $8,300 per year. These limits are set by law and exist to prevent people from using HSAs as general retirement accounts rather than healthcare savings tools. It is worth checking the IRS website or the guidance from your HSA provider each year, as these limits typically increase slightly to account for inflation.

Contribution limits also depend on how you are covered by your HDHP. If you are covered under only your own health insurance, you use the individual limit. If you have family coverage that includes a spouse or children, you use the family limit. If you have both individual coverage through your employer and family coverage through your spouse's employer, you must add up contributions from both accounts and ensure the total does not exceed the family limit for that year.

There are also special rules if you turn 55 years old during the year. Once you reach age 55, you can contribute an additional $1,000 per year to your HSA, called a "catch-up" contribution. This rule allows older workers to save more for healthcare expenses in retirement. This catch-up amount continues each year until you turn 65 and enroll in Medicare.

To calculate what you might contribute, start by determining your coverage type and finding the current year's limit. Then consider how much you expect to spend on medical expenses that year and how much you want to save for future years. Many people calculate this by reviewing their past medical expenses and adding a buffer for unexpected costs. For instance, if you typically spend $1,500 per year on medical care but want to start building a reserve, you might contribute $3,000 or $4,000 annually to reach the limit or a target amount.

It is important to understand that you do not have to contribute the maximum amount. You can contribute any amount up to the limit based on your personal finances and healthcare needs. Some people contribute smaller amounts if they have tight budgets, while others max out their contributions to gain the full tax benefit and build savings.

Practical Takeaway: Review the current IRS contribution limits for your coverage type, consider your expected medical expenses, and calculate a contribution amount that balances tax savings with your personal budget and savings goals.

Qualified Medical Expenses You Can Pay For With HSA Funds

One of the most important aspects of using an HSA correctly is understanding which expenses count as qualified medical expenses under IRS rules. Qualified expenses are those that you can pay for using HSA funds without facing taxes or penalties. The IRS maintains a comprehensive list, and it covers far more than just doctor visits.

Common qualified medical expenses include doctor visits and hospital care, prescription medications and over-the-counter medicines (with some restrictions), dental care and orthodontia, vision care including eye exams and glasses, hearing aids and hearing care, mental health and therapy services, and medical equipment such as wheelchairs, crutches, or blood pressure monitors. Prescription eyeglasses and contact lenses are covered, as are hearing aids and batteries for hearing aids. Therapy sessions with a licensed therapist are covered, as are psychiatric treatments.

Some expenses that surprise people are also covered. For example, you can use HSA funds to pay for fitness programs or gym memberships if they are prescribed by a doctor to treat a specific medical condition. Long-term care insurance premiums may be covered under certain circumstances. Certain travel expenses related to medical care, such as mile