What is an HSA?

What Is a Health Savings Account (HSA) and How Does It Work?

A Health Savings Account (HSA) is a tax-advantaged savings account designed to help individuals with a high deductible health plan (HDHP) cover medical expenses. HSAs allow people to set aside pre-tax money for qualified medical expenses, reducing taxable income while providing financial flexibility for health care costs. Understanding how HSAs work, their benefits, and potential downsides can help you decide if an HSA is the right fit for your needs.

How HSAs Work

HSAs function similarly to bank accounts, but funds are specifically designated for healthcare expenses. Here’s how they work:

• Eligibility Requirements – To open an HSA account, you must be enrolled in an HSA-eligible high deductible health plan.
• Contributions – Both individuals and employers can contribute to HSAs. Contributions are tax-deductible and subject to HSA contribution limits set by the IRS each year.
• Withdrawals – Funds can be used for qualified medical expenses tax-free at any time. If used for non-medical expenses, withdrawals are subject to income tax and a tax penalty if taken before age 65.
• Rollovers and Growth – Unlike a flexible spending account (FSA), HSA funds roll over each year and can be invested in mutual funds or other investment options, helping to grow savings over time.

HSA Feature	Details
Who Can Open?	Those enrolled in an HSA-eligible HDHP
Tax Benefits	Contributions are pre-tax, withdrawals for medical expenses are tax-free
Rollover	Unused funds roll over into next year
Investment Options	Funds can be invested in mutual funds, stocks, or bonds
Penalty for Non-Medical Use	20 percent tax penalty before age 65; no penalty after 65 (but subject to income tax)

The Benefits of an HSA

An HSA account offers several advantages for those looking to save on health care costs:

• Triple Tax Advantage – Contributions reduce taxable income, funds grow tax-free, and withdrawals for qualified expenses are tax-free.
• Long-Term Savings – HSA balances roll over each year and can be used in retirement for medical costs, including long-term care and Medicare premiums.
• Employer Contributions – Many employers contribute to employee HSAs, reducing out-of-pocket expenses.
• Flexible Withdrawals – Use HSA funds for expenses like copayments, coinsurance, prescription drugs, dental expenses, and preventive care.

Potential Downsides of HSAs

While HSAs provide many advantages, there are some drawbacks:

• Must Have an HDHP – You must be enrolled in an HSA-eligible high deductible health plan, which means higher out-of-pocket costs before insurance kicks in.
• Strict Contribution Limits – The IRS sets annual HSA contribution limits, which can limit savings potential.
• Penalties for Non-Medical Withdrawals – Using HSA funds for non-medical expenses before age 65 results in income tax and a 20 percent tax penalty.
• Requires Good Financial Planning – Those who don’t contribute regularly or plan ahead may struggle to cover large medical expenses.

HSA vs. FSA vs. HRA: Key Differences

While HSAs, FSAs, and HRAs all help with healthcare expenses, they work differently.

Feature	HSA	FSA (Flexible Spending Account)	HRA (Health Reimbursement Arrangement)
Who Owns It?	Individual	Employer	Employer
Rollover Allowed?	Yes	Limited	Yes
Employer Contributions?	Optional	Optional	Required
Investment Options?	Yes	No	No
Funds for Non-Medical Use?	Allowed (with tax/penalty)	No	No

What Happens to HSA Money If You Don’t Spend It?

One of the biggest benefits of HSAs is that unused funds roll over indefinitely. Unlike an FSA, where funds may be forfeited if not used within a year, HSA balances grow over time and can even be used in retirement for medical care or long-term care costs.

Can You Withdraw Money from an HSA for Non-Medical Expenses?

Yes, but with consequences:

• Before age 65: Subject to income tax and a 20 percent tax penalty.
• After age 65: No penalty, but withdrawals for non-medical expenses are subject to federal income tax.

Who Can Contribute to an HSA?

• Individuals enrolled in an HSA-eligible HDHP.
• Employers (contributions do not count toward taxable income).
• Family members on behalf of the HSA holder.

What Happens if Medical Expenses Exceed Your HSA Balance?

If your health savings account balance isn’t enough to cover medical expenses, you’ll need to pay the remainder out-of-pocket or use other financial resources. Some plans allow future reimbursements if you keep receipts and later add more funds.

FAQs

What is an HSA and how does it work?

An HSA is a tax-advantaged savings account for people with a high deductible health plan to pay for qualified medical expenses using pre-tax dollars.

What is the downside of having an HSA?

The main drawbacks are the requirement to have an HSA-eligible HDHP, potential out-of-pocket costs, and penalties for using funds on non-medical expenses before age 65.

What are the general features of an HDHP?

A high deductible health plan has higher deductibles and out-of-pocket costs but lower monthly premiums, making it ideal for those who want lower upfront costs and an HSA.

What is a triple tax advantage?

The triple tax advantage means HSA contributions are pre-tax, earnings grow tax-free, and withdrawals for qualified expenses are also tax-free.

Is an HSA Right for You?

A health savings account is a powerful tool for saving on healthcare expenses while enjoying tax benefits. If you have a high deductible health plan, regularly contribute to your HSA account, and plan for future medical costs, an HSA can be a smart investment. Be sure to check HSA contribution limits, IRS guidelines, and investment options to maximize your savings.