A Health Savings Account (HSA) is a tax-advantaged savings vehicle designed for individuals and families enrolled in high-deductible health plans (HDHPs). HSAs offer a unique triple tax benefit: contributions are tax-deductible (or pre-tax when made through payroll deductions), investment earnings grow tax-free, and withdrawals for qualified medical expenses—such as deductibles, copayments, coinsurance, and certain other healthcare costs—are exempt from taxes. HSA funds can be invested, allowing earnings to compound tax-free over time, making the account a powerful tool for managing both current and future healthcare expenses, including those in retirement. For eligible individuals and families, an HSA provides flexible savings and investment opportunities to address healthcare costs effectively. To learn more about how an HSA can benefit you, schedule a consultation with TrustTas Capital.
Everything You Need To Know
Health Savings Account
Overview
HDHP + HSA vs Traditional Plans
When selecting a healthcare plan, you may face a choice between a High-Deductible Health Plan (HDHP) paired with a Health Savings Account (HSA) or a traditional health plan. While the tax advantages of an HSA, combined with an HDHP, can be substantial, it’s critical to first determine whether an HDHP aligns with your and your family’s healthcare and financial needs. Medical expenses are often unpredictable, and financial circumstances can change, making this decision complex. It requires careful consideration of assumptions that may not always hold true. A holistic approach, weighing both costs and benefits, is essential.
Key factors to evaluate include prescription drug cost structures, copayment and coinsurance requirements, out-of-pocket maximums, out-of-network provider policies, and any employer contributions to HSAs. This decision is not solely financial—it also impacts your access to and quality of healthcare. Below is a brief overview of the key differences between HDHP + HSA and traditional health plans to guide your evaluation.
Feature |
HDHP + HSA |
Traditional Plans |
|---|---|---|
| Premiums | Typically lower monthly premiums | Typically higher monthly premiums |
| Deductible | Typically higher with IRS setting a minimum but can vary from plan to plan | Typically lower but can vary from plan to plan |
| Out-of-Pocket Maximum |
|
|
| Coinsurance | Typically higher percentage (e.g., 20-30%) after deductible is met but can vary from plan to plan | Typically lower percentage (e.g., 10-20%) after deductible is met but can vary from plan to plan |
| Co-Payment | Usually none until deductible is met; some plans may include copays afterward | Fixed amount (e.g., $20–$50) per visit, often before deductible |
| Prescription Drugs | Covered after deductible, often with higher coinsurance or tiered copays | Often covered with co-pays (e.g., $10–$30) or lower coinsurance, sometimes before deductible |
| Upfront Cost | Higher upfront cost until deductible is met | Routine care typically has lower upfront cost |
| Suitable For |
|
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Doing The Math – Which Is Better?
To determine the most cost-effective health plan for your needs, begin by reviewing your typical annual spending on medical care and prescription drugs. Understanding your historical costs allows you to make informed assumptions about future healthcare expenses. Use the formula below to calculate your estimated annual healthcare cost for both an HDHP + HSA and a traditional plan. Comparing these estimates will help you forecast which plan offers lower costs and better benefits based on your specific situation.
- Estimated Annual Healthcare Cost = Premiums + Estimated Out-of-Pocket Healthcare Costs − Employer HSA Contributions − Tax Savings On Your HSA Contribution
Examples
Examples: Selecting Between a HDHP + HSA and Traditional Healthcare Plan
When comparing a High-Deductible Health Plan (HDHP) paired with a Health Savings Account (HSA) to a traditional healthcare plan, the financial trade-offs depend on individual or family healthcare usage. The examples below illustrate these dynamics for a single individual, though the approach can be adapted for families. Note that every plan varies, so these scenarios rely on assumptions and require personalized calculations based on your circumstances.
| Health Insurance Options | HDHP | Traditional |
|---|---|---|
| Yearly Premiums | $7,000 | $8,500 |
| Deductible | $3,000 | $1,000 |
| Out-of-pocket Max | $6,000 | $3,500 |
| Coinsurance | 20% | 20% |
| Employer HSA Contribution | $500 | N/A |
| Personal HSA Contribution | $3,000 | N/A |
Scenario One: Best Case
- 0 doctor visits
- 0 prescriptions
- 24% tax-bracket
HDHP Calculation: $7,000 (premiums) + $0 (out-of-pocket) – $500 (employer HSA) – ($3,000 × 24%) = $7,000 + $0 – $500 – $720 = $5,780
Traditional Calculation:$8,500 (premiums) + $0 (out-of-pocket) = $8,500
Verdict – The HDHP + HSA offers a lower estimated annual cost by $2,720, making it the better choice in this scenario with minimal healthcare needs.
Scenario Two: Moderate case
- 4 doctor visits (average $300 each for HDHP or $50 copay for Traditional)
- 4 prescriptions (average $800 each for HDHP or $30 copay for Traditional)
- 24% tax-bracket
HDHP Calculation: $7,000 (premiums) + ($3,000 deductible + $280 coinsurance on $1,400 remaining after deductible) – $500 (employer HSA) – ($3,000 × 24%) = $7,000 + $3,280 – $500 – $720 = $9,060
Traditional Calculation: $8,500 (premiums) + ($200 copays + $120 prescription copays) = $8,500 + $320 = $8,820
Verdict – The traditional plan is more cost-effective by $240, making it the better choice with moderate healthcare usage.
Scenario Three: Worst Case
- Reaches out-of-pocket maximum due to ER visits, hospital stay, diagnostic tests, and surgery
- 24% tax-bracket
HDHP Calculation: $7,000 (premiums) + $6,000 (out-of-pocket max) – $500 (employer HSA) – ($3,000 × 24%) = $7,000 + $6,000 – $500 – $720 = $11,780
Traditional Calculation: $8,500 (premiums) + $3,500 (out-of-pocket max) = $12,000
Verdict – The HDHP + HSA is more cost-effective by $220, making it the better choice in a high-cost healthcare year.
Tip: Using GoodRx with a High-Deductible Health Plan (HDHP)
GoodRx is a consumer application that enables users to search for any medication, identify the lowest-cost pharmacy, and access digital coupons. By presenting the coupon on your phone at the pharmacy, you can benefit from discounted pricing. While GoodRx can be less advantageous with traditional health plans—where prescription copays or coinsurance often match or fall below GoodRx discounts—it serves as a valuable tool for individuals and families enrolled in an HDHP. With an HDHP, prescription drug costs are fully out-of-pocket until the deductible is met, making cost-saving options like GoodRx particularly relevant.
For HDHP enrollees, compare the total cost of meeting your deductible plus out-of-pocket expenses (e.g., copays and coinsurance) against potential savings with GoodRx. A practical guideline is: if you expect to easily meet your deductible, GoodRx may not be the most effective strategy, as insurance will cover costs thereafter. Conversely, if you anticipate minimal healthcare usage and will not reach your deductible, using GoodRx coupons can yield significant savings. The decision hinges on your specific circumstances and requires a detailed cost analysis.
An important consideration is that payments made using GoodRx do not count toward your deductible, as they bypass insurance. While you may attempt to submit a claim to your insurer afterward, approval is not guaranteed, and such payments may not be credited toward your deductible. This underscores the need to carefully weigh the immediate savings from GoodRx against the long-term benefit of progressing toward your deductible.
HSA’s Triple Tax Benefits
A Health Savings Account (HSA) stands out as one of the most powerful and tax-efficient savings vehicles available, specifically designed for individuals enrolled in high-deductible health plans (HDHPs) to manage healthcare costs. HSAs provide a unique triple tax advantage: contributions are tax-deductible (or pre-tax if made through payroll), earnings from interest or investments grow tax-free, and withdrawals for qualified medical expenses are exempt from taxes. This exceptional combination of benefits makes HSAs an effective tool for addressing current healthcare expenses while serving as a strategic asset for long-term financial planning, including retirement.
#1 ─ Tax-Deductible Contributions (or Pre-Tax if via Payroll)
Contributions to a Health Savings Account (HSA) are tax-deductible, lowering your taxable income for the year they are made. If contributions are deducted from your paycheck through an employer’s payroll system, they are made pre-tax, exempting them from federal income tax, Social Security tax, and Medicare tax. Similarly, employer contributions to your HSA are excluded from your taxable income, providing a valuable tax-free boost to your healthcare savings. For contributions made with after-tax dollars (e.g., via bank transfer or check), you can claim a deduction by filing IRS Form 8889 with your tax return, reducing your adjusted gross income (AGI).
- Example: consider an individual in the 24% federal tax bracket contributing $4,300 to their HSA. This reduces taxable income by $4,300, resulting in a federal tax savings of $1,032. If contributed via payroll, the savings would also include FICA taxes (7.65% of $4,300, or $328.95), bringing the total tax savings to $1,360.95.
#2 ─ Tax-Free Growth
The second component of the HSA’s triple tax advantage is the ability to achieve tax-free growth on earnings within the account. Once contributed, HSA funds can be invested in a range of options depending on the offerings of your HSA provider. Interest, dividends, and capital gains generated from these investments are exempt from federal income taxes, provided the funds remain in the HSA or are withdrawn for qualified medical expenses.
This tax-free compounding enables the account balance to grow over time without tax erosion, making it an effective tool for addressing both immediate healthcare needs and long-term wealth accumulation, especially for retirement planning. This feature is particularly beneficial for young, healthy individuals who can invest early and allow funds to grow over decades, as well as for those nearing retirement seeking to establish a dedicated healthcare reserve.
- Example: In a taxable brokerage account earning a 5% annual return, a 20% capital gains tax would reduce the effective return to 4%, significantly diminishing long-term growth. By contrast, an HSA’s tax-free growth preserves the full 5% return, maximizing the account’s value over time.
#3 ─ Tax-Free Withdrawals for Qualified Medical Expenses
The third pillar of the HSA’s triple tax advantage is the ability to withdraw funds tax-free when used for qualified medical expenses. This feature completes the HSA’s distinctive tax structure: contributions are tax-deductible, earnings grow tax-free, and distributions for eligible healthcare costs are exempt from federal income taxes. This end-to-end tax-free treatment—covering contribution, growth, and withdrawal—sets HSAs apart as one of the few financial accounts offering such comprehensive tax benefits, provided funds are used for IRS-approved medical expenses.
HSA funds have no expiration date, and you can even reimburse yourself for qualified expenses years later by retaining receipts — a strategy that allows your money to grow tax-free for longer. This flexibility enhances the account’s value, particularly in retirement when healthcare costs often increase. As long as withdrawals are applied to eligible medical expenses, they remain tax-free, positioning the HSA as a unique tool for achieving truly triple tax-free financial growth.
HSA in Retirement Planning
Health Savings Accounts (HSAs) offer a powerful, tax-advantaged approach to saving for healthcare costs in retirement, a period when such expenses can become a significant financial burden. Recent estimates indicate that a 65-year-old couple may face up to $300,000 in medical costs throughout their retirement years. When leveraged effectively, HSAs provide compounding benefits, particularly when contributions are maximized annually and initiated early in one’s career.
An optimal strategy involves maximizing annual HSA contributions, covering current medical expenses with personal savings or income, and investing the HSA funds in low-cost index funds to build a substantial retirement nest egg. This approach enables tax-free withdrawals in retirement for expenses such as Medicare premiums, prescription drugs, and unexpected medical bills, thereby preserving other retirement assets and enhancing long-term financial stability.
HSAs also offer unique flexibility, allowing account holders to pay out-of-pocket for medical expenses while retaining receipts for tax-free reimbursements at any time, including during retirement or periods of need. This facilitates decades of tax-free growth through compound interest. After age 65, HSA funds can be withdrawn for non-medical purposes without the 20% penalty that applies to earlier non-qualified withdrawals (though such withdrawals are subject to income tax), making the HSA a versatile complement to retirement savings vehicles like 401(k)s or IRAs.
Contributions
Eligibility Criteria
To contribute to a Health Savings Account (HSA), individuals must meet specific eligibility requirements established by the Internal Revenue Service (IRS). These criteria ensure that HSAs are utilized in conjunction with high-deductible health plans (HDHPs), promoting a proactive approach to managing healthcare costs. Failure to satisfy any of these requirements may result in disqualification from making HSA contributions, underscoring the importance of understanding these rules to fully leverage the financial and healthcare benefits an HSA provides. Eligibility criteria include the following factors:
- 1 ─ Must Be Enrolled HDHP
- 2 ─ Cannot Have Other Health Coverage
- 3 ─ Cannot Be Claimed as a Dependent
- 4 ─ Must Not Be Enrolled in Medicare
↳ 1 ─ You Must Be Enrolled in a Qualified High Deductible Health Plan (HDHP)
The cornerstone requirement for contributing to a Health Savings Account (HSA) is enrollment in a qualified High-Deductible Health Plan (HDHP). While many health insurance plans feature high deductibles, not all meet the specific criteria established by the Internal Revenue Service (IRS) for HSA eligibility. Simply having a high deductible does not automatically qualify a plan; it is essential to confirm with your insurance provider or employer that the plan adheres to IRS HDHP standards.
To be considered a qualified HDHP, a plan must meet minimum deductible thresholds and adhere to a maximum out-of-pocket limit, both of which the IRS adjusts annually to reflect inflation and healthcare cost trends. These IRS-defined limits are tabbed below:
Tax Year 2025
| Type of Limit | Individual | Family |
|---|---|---|
| Minimum Deductibility | $1,650 | $3,300 |
| Maximum Out-of-Pocket | $8,300 | $16,600 |
Tax Year 2024
| Type of Limit | Individual | Family |
|---|---|---|
| Minimum Deductibility | $1,600 | $3,200 |
| Maximum Out-of-Pocket | $8,050 | $16,100 |
In addition to these thresholds, a qualifying HDHP typically does not cover most non-preventive medical services until the deductible is met. This means you are responsible for the full cost of services—such as routine doctor visits, imaging, lab work, and prescriptions—until the deductible is satisfied. An important exception applies to preventive care: services like annual physicals, vaccinations, and screenings (e.g., mammograms, colonoscopies), as defined as preventive under the Affordable Care Act (ACA), are often covered in full before the deductible is reached.
↳ 2 ─ You Cannot Have Other Health Coverage
A critical condition for HSA eligibility is that you cannot have other healthcare coverage that disqualifies you under IRS rules. You must not have secondary health insurance or benefits that cover medical expenses before your HDHP deductible is met. For instance, coverage under a spouse’s non-HDHP plan or a general-purpose Flexible Spending Account (FSA) that pays for medical costs prior to satisfying the HDHP deductible may disqualify you from contributing to an HSA.
Certain limited exceptions are permitted, including coverage for dental, vision, accident, disability, workers’ compensation, or specific preventive services that comply with federal guidelines under the Affordable Care Act (ACA). However, most traditional or supplemental health plans that provide benefits before the HDHP deductible is met will render you ineligible for HSA contributions.
↳ 3 ─ You Cannot Be Claimed as a Dependent on Someone Else’s Tax Return
A key requirement for contributing to a Health Savings Account (HSA) is that you must not be claimed as a dependent on another individual’s federal income tax return. Even if you satisfy all other eligibility criteria—such as enrollment in a qualified High-Deductible Health Plan (HDHP) and the absence of disqualifying secondary coverage—you are ineligible to contribute to an HSA if someone else is eligible to claim you as a dependent for the tax year, regardless of whether they actually do so. This rule commonly applies to young adults and college students who may otherwise be supported by parents or guardians.
What is a tax dependent?
↳ 4 ─ You Must Not Be Enrolled in Medicare (Typically Age 65)
To contribute to a Health Savings Account (HSA), you must not be enrolled in Medicare. Eligibility is not determined by age alone but by enrollment in any part of Medicare (Part A, Part B, Part C, or Part D), which disqualifies you from making HSA contributions. Once enrolled, you no longer meet the IRS requirement of relying solely on a qualified High-Deductible Health Plan (HDHP) as your primary health coverage. This rule frequently impacts individuals who begin receiving Social Security benefits at or after age 65, as they are typically automatically enrolled in Medicare Part A.
Mid-Year Loss Rule
If you lose eligibility for a Health Savings Account (HSA) mid-year—due to switching to a non-qualified High-Deductible Health Plan (HDHP), enrolling in Medicare, obtaining disqualifying coverage (e.g., a spouse’s non-HDHP plan), or becoming a tax dependent—your contribution limit is prorated based on the number of months you were eligible. A month is considered eligible if you are enrolled in a qualified HDHP (and meet all other eligibility criteria) on the first day of that month. The proration formula is:
-
Prorated Limit = Annual Limit × (Number of Eligible Months / 12)
Example: For 2025, if you are single and eligible for an HSA from January to June (6 months), with an annual contribution limit of $4,300 for individual coverage, the prorated limit is $4,300 × (6/12) = $2,150. You can contribute this amount by the tax filing deadline, April 15, 2026, for the 2025 tax year.
Last-Month Rule
If you become eligible for a Health Savings Account (HSA) by December 1 of a given tax year, you may contribute the full annual HSA limit by the tax filing deadline, even if you were not eligible for the entire year. For example, if you enroll in a qualified High-Deductible Health Plan (HDHP) on December 1, 2025, you can contribute the full 2025 limit by April 15, 2026, for that tax year.
However, this benefit is contingent on meeting specific conditions. You must remain HSA-eligible throughout the testing period, which spans 12 months from the date you become eligible and ends on the last day of the 12th month (e.g., December 31, 2026, for eligibility beginning December 1, 2025). If you fail the testing period—such as by enrolling in Medicare or gaining disqualifying coverage—any contributions exceeding the prorated limit based on your actual eligible months become excess contributions. These excess amounts are subject to income tax and a penalty.
Example: If you are single and enroll in an HDHP on December 1, 2025, you can contribute the full $4,300 by April 15, 2026. However, if you enroll in Medicare on July 1, 2026, your eligibility for the 2025 tax year is limited to 1 month (December 2025). The prorated limit for 2025 is $4,300 × (1/12) = $358.33. The excess contribution ($4,300 – $358.33 = $3,941.67) is subject to penalty and is included in your taxable income. At a 22% tax bracket, it would incur $867.17 in federal income tax.
Annual Contribution Limits
Each year, the Internal Revenue Service (IRS) sets contribution limits for Health Savings Accounts (HSAs), establishing the maximum amounts individuals and families can contribute to these tax-advantaged accounts. Understanding these limits is essential for maximizing the triple tax benefits while ensuring compliance with federal regulations. Whether you are saving for current healthcare costs or building a nest egg for future needs, awareness of these thresholds enables effective planning and helps avoid penalties. These limits, adjusted for inflation, are as follows:
↳ 2025 Tax Year
| Coverage Type | Contribution Limits |
Catch Up (Age 55 +) |
|---|---|---|
| Individual | $4,300 | + $1,000 |
| Family | $8,550 | + $1,000 (per eligible person) |
-
If you’re 55 or older, you can contribute an additional $1,000 as a catch-up contribution. Both spouses aged 55 or older can each make a $1,000 catch-up contribution, provided each has a separate HSA.
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These limits encompass all contributions, whether from you, your employer, or others (e.g., family members).
↳ 2024 Tax Year
| Coverage Type | Contribution Limits |
Catch Up (Age 55 +) |
|---|---|---|
| Individual | $4,150 | + $1,000 |
| Family | $8,300 | + $1,000 (per eligible person) |
-
If you’re 55 or older, you can contribute an additional $1,000 as a catch-up contribution. Both spouses aged 55 or older can each make a $1,000 catch-up contribution, provided each has a separate HSA.
-
These limits encompass all contributions, whether from you, your employer, or others (e.g., family members).
Employer Contributions
Employer contributions to Health Savings Accounts (HSAs) provide a valuable benefit for employees enrolled in a qualified High-Deductible Health Plan (HDHP). These contributions are deposited directly into your HSA on a pre-tax basis, excluded from your taxable income, and thereby reduce your federal income tax, Social Security tax, and Medicare tax liabilities.
Example: If your employer contributes $2,000 to your HSA and you are in the 24% federal tax bracket, you save $480 in federal income tax ($2,000 × 24%), approximately $124 in Social Security tax ($2,000 × 6.2%), and $29 in Medicare tax ($2,000 × 1.45%), totaling $633 in tax savings (excluding any applicable state taxes).
Employers also benefit, as their HSA contributions are deductible as a business expense and exempt from payroll taxes, including Social Security, Medicare, and federal unemployment taxes, encouraging them to offer this benefit. Understanding key aspects—such as how employer contributions count toward the annual HSA limit, their tax benefits, your ownership of the account, and potential variations in contribution amounts—is essential for maximizing your HSA’s value and planning effectively for healthcare and financial needs.
Important Key Notes
- Contribution Limits: Employer contributions are included in the annual IRS HSA contribution limits. The total of all contributions (from employers, personal sources, and other contributors) must not exceed these limits to avoid a 6% excise tax on excess amounts.
- Account Ownership: HSA funds are 100% vested upon deposit, meaning you own them outright. These funds remain in your HSA even if you change employers or retire, providing long-term flexibility.
- Contribution Variations: Employers may contribute through lump-sum payments, monthly deposits, or matching programs (e.g., matching your contributions up to a specified amount).
- Tax Reporting: Employer contributions are reported on your W-2 (Box 12, Code W), and all HSA contributions and distributions must be documented on IRS Form 8889 when filing your taxes.
Contribution Deadlines
The contribution deadline for a Health Savings Account (HSA) is April 15 of the following year, aligning with the federal income tax filing deadline. For instance, contributions for the 2025 tax year can be made until April 15, 2026. This deadline applies to both personal and employer contributions, including any matching contributions, provided you were HSA-eligible during the relevant months of 2025. Understanding this deadline is essential for maximizing tax benefits and ensuring compliance with IRS regulations.
Qualified HSA Funding Distribution (QHFD) — IRA to HSA Transfer
A Qualified HSA Funding Distribution (QHFD) is a one-time, tax-free transfer of funds from an Individual Retirement Account (IRA) to a Health Savings Account (HSA), as permitted by the IRS under strict conditions. This strategic option allows you to fund your HSA without using out-of-pocket cash, provided you adhere to the rules. A QHFD enables a direct trustee-to-trustee transfer from a Traditional or Roth IRA to your HSA, avoiding income taxes or early withdrawal penalties. To qualify, you must:
- Be HSA-eligible at the time of the transfer (enrolled in a qualified High-Deductible Health Plan [HDHP], not enrolled in Medicare, without disqualifying coverage, and not claimed as a tax dependent).
- Not have previously completed a QHFD, as it is a once-in-a-lifetime opportunity per individual.
- Ensure the transfer amount, combined with other HSA contributions for the year, does not exceed the IRS annual contribution limit
Important Key Notes
- One-Time Opportunity: You are limited to a single QHFD in your lifetime, with no exceptions or reversals.
- No Inherited IRAs: Funds from inherited IRAs are ineligible for a QHFD.
- No Employer Plans: 401(k)s or other workplace retirement plans cannot be used directly; they must first be rolled into a Traditional or Roth IRA.
- Roth IRA Transfers: Allowed, but often inadvisable, as it sacrifices the Roth’s tax-free growth for an HSA’s similar tax-free withdrawal benefits for medical expenses.
- Direct Trustee-to-Trustee Transfer: The transfer must be conducted directly from the IRA custodian to the HSA provider; withdrawing funds yourself and depositing them into your HSA disqualifies the transaction.
- Testing Period: Following the QHFD, you must remain HSA-eligible for 12 months after the month of the transfer (e.g., if completed in June 2025, eligibility must continue through June 30, 2026). Losing eligibility during this period (e.g., switching to a non-HDHP or enrolling in Medicare) renders the entire transferred amount taxable income, subject to penalty plus applicable income tax.
- Example: If you transfer $4,300 from a Traditional IRA to your HSA in July 2025 but enroll in Medicare in January 2026, your eligibility ends after 6 months. The full $4,300 becomes taxable income. At a 22% tax bracket, this incurs $946 in federal income tax
Investments
A Health Savings Account (HSA) extends beyond a tool for managing medical expenses, serving as a powerful, triple tax-advantaged vehicle for building savings for future healthcare or retirement. Most HSA providers offer two sub-accounts: (1) a cash account for immediate liquidity and (2) an investment account for long-term growth. The administration of these accounts, available investment options, and associated fees vary by provider, making your choice of HSA provider a critical decision. For our HSA provider recommendations, please refer to the Recommended HSA Provider page.
Cash Account
The cash account emphasizes liquidity and stability, functioning similarly to a savings or checking account. It typically earns modest interest (ranging from 0.01% to 0.70% APY, depending on the provider and balance) and is intended for immediate medical expenses, accessible via debit card, checks, or online bill pay. Most cash accounts are FDIC-insured, safeguarding the principal without requiring liquidation of investments. Many providers mandate a minimum cash balance (e.g., $500–$2,000) before funds can be allocated to the investment account.
Example: If your HSA balance is $5,000 and your provider requires a $1,000 minimum cash balance, you can invest up to $4,000, retaining $1,000 in the cash account for immediate access.
Investment Account
The investment account allows you to invest in a range of securities, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), and occasionally certificates of deposit (CDs) or real estate funds, depending on the HSA provider. This account is designed for long-term growth, particularly beneficial if you can cover current medical expenses out-of-pocket, enabling HSA funds to grow tax-free. Unlike cash accounts, investment accounts are not FDIC-insured and are subject to market risks, including the potential loss of principal.
Distributions
Qualified Distributions
One of the most significant advantages of a Health Savings Account (HSA) is the ability to take tax-free distributions for qualified medical expenses, fully realizing its triple tax benefit: tax-deductible contributions, tax-free growth, and tax-free withdrawals. These distributions enable account holders to cover a broad spectrum of healthcare costs without incurring tax liability, making HSAs an effective tool for managing medical expenses both currently and in retirement. Understanding which expenses qualify is crucial to maximize your HSA benefits and avoid penalties, such as a 20% penalty plus income tax on non-qualified withdrawals before age 65. Below is a comprehensive list of qualified medical expenses, as defined by IRS Publication 502:
- Doctor visits (co-pays, deductibles, fees)
- Prescription medications
- Dental and vision care (e.g., exams, glasses, contacts)
- COBRA premiums
- Medicare premiums (Part B, Part D, and Medicare Advantage – but not Medigap)
- Menstrual products
- Fertility treatments
- Vaccinations and preventive care
- Chiropractic and physical therapy
- Mental health services
- Medical equipment and supplies (e.g., crutches, wheelchairs)
- Long-term care services and certain premium costs
- Hospital services
- Laboratory fees
- Acupuncture
- Over-the-counter medications (with a letter of medical necessity from a healthcare provider)
Important Key Notes
- Delayed Reimbursement: You may reimburse yourself for qualified medical expenses incurred after establishing your HSA, even years later, as long as you retain receipts or proof of payment to substantiate the expense.
- Documentation: Keep detailed records (e.g., receipts, prescriptions, Explanation of Benefits) for all HSA distributions, as the IRS may audit to verify expenses are qualified.
- Keep a digital archive of receipts and match them to withdrawal records.
- Tax Reporting: Report all HSA distributions on IRS Form 8889 with your tax return, ensuring they align with qualified expenses to avoid IRS scrutiny.
Non-Qualified Distributions
Health Savings Accounts (HSAs) provide exceptional triple tax benefits, but these advantages are contingent upon proper usage. Non-qualified distributions—withdrawals for expenses not recognized as IRS-approved medical costs—result in significant tax consequences. Prior to age 65, such withdrawals are subject to regular income tax plus a 20% IRS penalty. After age 65, the penalty is waived, but the amount withdrawn is still subject to income tax. Understanding these non-qualified expenses and their associated penalties is essential to preserve your HSA’s value and avoid costly mistakes. Below are the tax and penalty implications for non-qualified distributions before and after age 65:
↳ Before Age 65
If you withdraw funds from your Health Savings Account (HSA) for non-medical purposes before age 65, the IRS imposes the following consequences:
- Regular Income Tax: The withdrawal is taxed at your marginal federal income tax rate.
- EX: A $1,000 non-qualified withdrawal in the 22% federal tax bracket adds $220 to your tax liability.
- 20% IRS Penalty: An additional 20% penalty is applied to the withdrawn amount.
- EX: A $1,000 non-qualified withdrawal incurs a $200 penalty.
Example:If you are 40 years old and withdraw $2,000 for a vacation, you would owe $440 in federal income tax (22% of $2,000) plus a $400 penalty (20% of $2,000), totaling $840 in federal tax and penalty obligations.
↳ After Age 65
If you withdraw funds from your Health Savings Account (HSA) for non-medical purposes after age 65, the IRS applies the following:
- Regular Income Tax: The withdrawal is taxed at your marginal federal income tax rate, with no additional penalty.
Example: If you are 66 and withdraw $2,000 for home repairs, you owe $440 in income tax (at a 22% tax bracket), but no penalty applies, enhancing the HSA’s flexibility as a retirement savings tool.
Common Non-Qualified Expenses
The following are examples of expenses that do not qualify for tax-free HSA distributions, as outlined by the IRS in Publication 502. Using HSA funds for these purposes incurs the penalties described previously:
- Cosmetic procedures (e.g., elective surgery for aesthetic purposes)
- Gym memberships or fitness programs
- General health items (i.e. toothbrushes, etc.)
- Childcare or dependent care cost
- Vitamins and supplements (unless prescribed for a specific medical condition)
- Medigap premiums
- Non-prescribed over-the-counter items (without a letter of medical necessity)
- Funeral expenses
No RMDs (Required Minimum Distributions)
Unlike many retirement accounts, such as Traditional IRAs or 401(k)s, Health Savings Accounts (HSAs) are not subject to Required Minimum Distributions (RMDs) during the account holder’s lifetime. This unique feature allows you to let your HSA funds grow tax-free indefinitely, providing flexibility to save for future healthcare costs or other needs without mandatory withdrawals at a specific age.
Inheritance and Death
A critical yet often overlooked aspect of Health Savings Accounts (HSAs) is the treatment of funds following the account holder’s death. While HSAs offer exceptional triple tax advantages during the owner’s lifetime, the rules governing inheritance can significantly impact the remaining balance. The outcome varies depending on whether the beneficiary is a spouse, a non-spouse individual, or an estate, affecting both tax liability and the account’s status. Understanding these provisions is vital for effective estate planning and ensuring the HSA’s value is preserved for heirs in a tax-efficient manner. Below are the key rules and considerations for different beneficiary types:
↳ Spouse Beneficiary
If the beneficiary of a Health Savings Account (HSA) is the account holder’s spouse, the HSA transfers to the spouse and becomes their own HSA, preserving its tax-advantaged status. There is no immediate tax liability upon transfer. The spouse can use the funds tax-free for their own qualified medical expenses, continue making contributions if they remain HSA-eligible, or invest the funds for tax-free growth.
Example: If Jane, age 60, inherits John’s $10,000 HSA and remains HSA-eligible, she assumes ownership of the account. In 2025, she can contribute up to $5,300 ($4,300 for self-only coverage plus a $1,000 catch-up contribution, as she is 55 or older). She can also use $2,000 tax-free for LASIK surgery, leaving $8,000 of the inherited HSA to grow tax-free through investment.
↳ Non-Spouse Beneficiary
If the beneficiary of a Health Savings Account (HSA) is a non-spouse (e.g., child, sibling, or friend), the HSA ceases to exist as an HSA upon the account holder’s death. The entire balance, valued at its fair market value on the date of death, is distributed to the beneficiary and treated as taxable income to them in the year of death. No additional penalty applies.
Example: If a daughter inherits a $10,000 HSA and is in the 24% federal tax bracket, she receives a taxable distribution of $10,000, resulting in a federal income tax liability of $2,400. She cannot use the funds for tax-free medical expenses or continue the HSA as her own.
FAQs
Am I eligible to contribute to an HSA?
You are eligible to contribute to an HSA if you are enrolled in a qualified High-Deductible Health Plan (HDHP), have no other disqualifying health coverage (e.g., Medicare or a non-HDHP plan) and are not claimed as a dependent on someone else’s tax return. Enrollment in Medicare typically disqualifies you. Refer to the eligibility criteria section for more information.
What happens if I use HSA funds for non-medical expenses?
Before age 65, non-qualified withdrawals are subject to your marginal income tax rate plus a 20% penalty. After age 65, the penalty is waived, but the withdrawal is still taxed as ordinary income. Examples of non-qualified expenses include cosmetic procedures and gym memberships.
Can I leave HSA funds untouched for retirement?
Yes, HSAs have no Required Minimum Distributions (RMDs), allowing funds to grow tax-free indefinitely. You can reimburse yourself for qualified medical expenses years later with saved receipts, making it a flexible retirement savings tool.