Learn About Health Savings Accounts and How They Work

What Is a Health Savings Account?

A Health Savings Account, commonly called an HSA, is a type of savings account designed specifically for healthcare costs. Unlike a regular savings account at a bank, an HSA offers tax advantages that can help you save money on medical expenses. The account belongs to you individually, meaning you own it and control how the money is used.

HSAs were created in 2003 as part of the Medicare Modernization Act. The basic idea is straightforward: you put money into the account before taxes are taken out of your paycheck, use that money to pay for medical expenses, and the money grows without being taxed. This structure makes HSAs different from other ways people typically pay for healthcare.

Think of an HSA as a three-layer benefit. First, the money you contribute reduces your taxable income, which means you pay less in income taxes. Second, the money in the account grows without being taxed, similar to how retirement accounts work. Third, when you withdraw money to pay for qualified medical expenses, that withdrawal is not taxed. This triple tax advantage is what makes HSAs valuable for people who use them.

According to the Employee Benefit Research Institute, approximately 29 million Americans had HSAs in 2022, showing significant growth in their use. The average HSA balance for individuals who contribute regularly grows over time, with many people using their accounts both as immediate healthcare payment tools and as long-term savings vehicles.

HSAs are portable, meaning you keep the account even if you change jobs. The money you contribute stays in the account and continues to grow. This portability makes HSAs attractive compared to some other healthcare benefits that disappear when you leave a job.

Practical Takeaway: An HSA is a tax-advantaged savings account specifically for healthcare expenses. Understanding that HSAs offer three types of tax benefits — on contributions, growth, and withdrawals — helps explain why people choose to use them alongside their health insurance.

Eligibility Requirements and Account Setup

To open and use an HSA, you must meet certain requirements. The primary requirement is that you must be covered by a high-deductible health plan, or HDHP. An HDHP is a type of health insurance with lower monthly premiums but higher deductibles than traditional health plans. For 2024, the IRS defines an HDHP as a plan with a minimum deductible of $1,600 for individual coverage or $3,200 for family coverage.

You cannot have other health coverage that is not considered an HDHP. This means you cannot be covered by Medicare, Medicaid, or a non-HDHP plan from your employer or a spouse's employer at the same time you are contributing to an HSA. There are some exceptions to this rule — for example, you can have dental, vision, or accident coverage alongside an HDHP without losing HSA options.

Age matters as well. You must be under age 65 to contribute to an HSA. Once you reach 65, you can no longer make new contributions, though you can continue using money already in the account. Additionally, you cannot be claimed as a dependent on someone else's tax return to contribute to an HSA.

Setting up an HSA involves choosing a provider. Many banks, credit unions, and financial institutions offer HSAs. Some employers offer HSAs through a specific provider, while others allow employees to choose their own. When selecting a provider, consider factors like fees, interest rates on balances, investment options, and how easy the account is to use for making medical payments.

The contribution process can happen through payroll deductions if your employer offers this option, or you can contribute directly to the account yourself. Payroll deduction is common because it takes money from your paycheck before taxes are calculated, which automatically gives you the tax deduction benefit.

Practical Takeaway: To use an HSA, you need an HDHP and must meet age and coverage requirements. Comparing different HSA providers helps you find one that matches your needs and won't cost you money in unnecessary fees.

Contribution Limits and Annual Rules

The IRS sets annual limits on how much money you can contribute to an HSA. These limits change each year and differ based on whether you have individual or family coverage. For 2024, the contribution limit is $4,150 for individual coverage and $8,300 for family coverage. These limits are set each year and typically increase slightly to account for inflation.

An important rule is that you can only contribute the full annual amount if you have HSA-eligible coverage for the entire year. If you enroll in an HDHP mid-year, your contribution limit is reduced. For example, if you start HDHP coverage in July, you can contribute only half the annual limit. However, there is an exception called the "last month rule" that allows you to contribute the full annual amount if you are covered on the first day of the last month of the year, provided you maintain coverage for the following 12 months.

Some employers contribute money to their employees' HSAs as part of their benefits package. When an employer contributes, that contribution counts toward the annual limit. For instance, if your employer contributes $1,000 to your HSA and you want to reach the full limit, you can only contribute an additional $3,150 (using the 2024 individual limit).

Self-employed individuals and people without employer HSA plans can set up and contribute to HSAs on their own. The same annual limits apply. Self-employed people may also be able to deduct HSA contributions on their tax returns, similar to how other retirement savings work.

Unlike some retirement accounts, HSAs do not have a "use it or lose it" rule. Money you don't spend carries over to the next year. This feature is what makes HSAs work as long-term savings tools — people can intentionally leave money in the account to grow for future healthcare needs rather than feeling pressured to spend it by a deadline.

Practical Takeaway: Know your annual contribution limit and track employer contributions toward that limit. Since HSA money rolls over year to year, you can save strategically for future healthcare expenses rather than spending money just to use it.

Qualified Medical Expenses and How to Use Funds

HSA funds must be used for "qualified medical expenses" to avoid taxes and penalties on withdrawals. The IRS has a specific list of what counts as qualified. Common examples include doctor visits, hospital stays, prescription medications, dental work, vision care, and mental health treatment. Surgical procedures, X-rays, lab tests, and medical equipment like wheelchairs or hearing aids are also covered.

Insurance-related costs also count as qualified expenses. You can use HSA funds to pay health insurance premiums for COBRA coverage (continuation coverage when leaving a job), Medicare premiums once you turn 65, and long-term care insurance premiums up to certain limits. Deductibles, copayments, and coinsurance on your HDHP are all qualified expenses as well.

Some healthcare-related costs do not qualify. Over-the-counter medications typically do not count unless you have a doctor's prescription. Cosmetic procedures are not covered. Health club memberships, vitamins, and general wellness products that are not prescribed are not qualified expenses. This distinction matters because using HSA funds for non-qualified expenses triggers taxes and a 20 percent penalty on the withdrawal amount.

Withdrawing money from an HSA is straightforward. Many HSA providers issue debit cards that you can use directly at pharmacies, doctor offices, and hospitals. You can also request checks, make transfers, or reimburse yourself for out-of-pocket medical expenses. Some people keep receipts and reimburse themselves months or years later, leaving the money in the account to grow in the meantime.

There is no requirement to withdraw money immediately. This flexibility means you could pay a medical expense out of pocket, keep your HSA funds invested, and reimburse yourself at a later date. This strategy works for people who want their HSA to function as a long-term investment account rather than just a short-term payment tool.

Keeping documentation is important. The IRS requires that you maintain records connecting HSA withdrawals to qualified medical expenses. You should save receipts and medical statements showing that the expenses you paid for were legitimate healthcare costs. While the IRS does not typically require you to submit these records with your tax return, having them available protects you if your account is audited.