A Health Savings Account (HSA) is a specialized savings account designed to help individuals save for qualified medical expenses. It is a tax-advantaged financial tool, allowing contributions, earnings, and withdrawals for eligible healthcare costs to be free from federal income tax. An HSA provides a dedicated fund for healthcare expenditures, often complementing a specific type of health insurance plan.
Who Can Have an HSA
Eligibility for an HSA is tied to specific Internal Revenue Service (IRS) guidelines. To open and contribute to an HSA, an individual must be enrolled in a High-Deductible Health Plan (HDHP). These plans typically feature lower monthly premiums but require a higher deductible before coverage begins. An individual cannot be enrolled in Medicare or be claimed as a dependent on someone else’s tax return.
The IRS sets specific annual contribution limits, which can vary year to year. For instance, in 2025, an individual can contribute up to $4,300 to an HSA, while a family can contribute up to $8,550. Individuals aged 55 and older are permitted to make an additional “catch-up” contribution of $1,000 annually. These limits apply to both individual and employer contributions combined.
What Funds Cover
HSA funds can be used for a wide array of qualified medical expenses, offering flexibility in managing costs. These include medical, dental, and vision care, such as prescription medications, eyeglasses, contact lenses, dental cleanings, fillings, and orthodontic treatments. The IRS provides detailed guidance on qualified medical expenses in Publication 502.
Covered expenses also include mental health services, over-the-counter medications with a medical purpose, and medical equipment like crutches or wheelchairs. Funds can be used for deductibles, copayments, and coinsurance, which are the out-of-pocket costs a person pays before their insurance begins to cover expenses. This broad coverage ensures HSA funds can address diverse healthcare needs.
Understanding the Tax Advantages
An HSA offers a “triple tax advantage.” First, contributions made to an HSA are tax-deductible, reducing an individual’s taxable income. This applies whether contributions are made directly by the individual or through pre-tax payroll deductions by an employer. This initial tax benefit provides immediate income tax savings.
Second, funds within an HSA grow tax-free through investments. Unlike standard investment accounts where earnings are taxed annually, any interest, dividends, or capital gains generated by the HSA balance are not subject to federal income tax. This allows the account to accumulate wealth rapidly over time.
Finally, withdrawals from an HSA are tax-free as long as they are used for qualified medical expenses. This means that when an individual uses their HSA funds to pay for eligible healthcare costs, they do not owe any federal income tax on those withdrawals. This combination of tax-deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses distinguishes HSAs as a unique and advantageous savings vehicle.
Integrating HSA into Financial Planning
An HSA can serve as a long-term savings and investment vehicle, extending beyond immediate needs. Its portability means the account belongs to the individual, not the employer, remaining with them even if they change jobs or retire. Funds within an HSA also roll over year to year, unlike some other health savings accounts, ensuring that unused balances accumulate over time. This allows individuals to build a substantial reserve for future medical expenses.
The HSA is valuable in retirement planning. While contributions can cover current medical costs, the ability to invest the funds allows for potential growth over decades. In retirement, individuals can continue to use HSA funds tax-free for qualified medical expenses, which often increase with age. After age 65, HSA funds can be withdrawn for non-medical expenses without the 20% penalty, though these withdrawals are subject to income tax. This flexibility positions the HSA as a versatile component of a comprehensive financial strategy, offering both immediate healthcare funding and a long-term savings asset.