Health savings accounts (HSAs), explained: Taxes, eligibility & more

Figuring out how to pay for health care is something everyone grapples with. Access to employer-sponsored insurance plans or what you can get in the health insurance marketplace plays a big role in what out-of-pocket costs you'll face. Even with health insurance, you may find yourself coming up short when it comes time to pay medical bills, particularly when you weren't anticipating them.

One way you can prepare for your future is by opening a health savings account (HSA) alongside your high-deductible health insurance plan. These accounts don't just encourage you to set aside money—they can provide tax advantages and be a vehicle for retirement savings. It's a flexible and portable option that's worth exploring.

An HSA is a special spending account where you can deposit pre-tax money for medical expenses. You can spend HSA dollars on qualified medical expenses, which are defined fairly broadly. They include not just doctor and hospital visits but also other products and services, from home health care supplies to certain kinds of therapy.

You don't have to pay income tax on your HSA dollars as long as they're used for qualified expenses, making the money tax-free both going in and coming out. Further, HSA funds can be invested and earn interest through an HSA-providing bank, insurance company or financial institution. That means you can earn returns on those funds that also aren't subject to income tax.

When you deposit money into an HSA, it's typically with untaxed dollars. This might be arranged through a payroll deduction, or you can report how much you contributed to your HSA on your tax return, reducing your taxable income for that year. Just be aware that you'll have to stop contributing in any year that you aren't on an eligible plan. For instance, if you were to enroll in Medicare during retirement, you'd no longer be eligible to make HSA contributions. Regardless of your contributing status, however, you can spend your HSA funds at any time.

Many HSAs issue a debit card or checks that you spend from, similar to a checking account. When you spend on nonmedical expenses, there is a 20% penalty, so always double-check that an expense is qualified. And if you don't end up using all your HSA money within the year, it will just accumulate for you to use in the future.

HSAs are also portable, which means they stay with you even after a job change. And some people like the added control that comes with coupling an HSA with a high-deductible health plan.

HSA eligibility is only available with certain high-deductible plans that you usually get through your employer or the Health Insurance Marketplace. For many of these, you'll pay more out of pocket upfront for the care and procedures you receive until you reach your deductible. Your health plan must have at least a:

• $1,600 deductible for individuals or $3,200 for families in 2024.
  Or,
• $1,650 deductible for individuals or $3,300 for families in 2025.

You'll have the option of contributing up to the current limit per year:

• 2024 HSA contribution limit: $4,150 for an individual and $8,300 for a family
• 2025 HSA contribution limit: $4,300 for an individual and $8,550 for a family
  

The annual HSA contribution limits are higher for people ages 55 and older through a catch-up contribution. In this case, you can contribute an extra $1,000 in addition to the annual limit.

An HSA is essentially a tax-advantaged account you tuck away to help you cover whatever your health insurance doesn't. They offer significant tax benefits as they allow for tax-deductible contributions, tax-free growth and tax-free withdrawals for qualified medical expenses.

The tax advantages an HSA can offer may be valuable for people looking to lower their tax burden. Even if you don't spend up to the HSA limit on medical expenses each year, letting money accumulate in the HSA can be both a safety net for future years with higher medical expenses and a way to earn some tax-advantaged interest or dividends (and even more if the HSA is able to be invested).

Plus, employers may offer a benefit where they contribute tax-free dollars to the HSA as well, which is an added incentive.

Your individual insurance plan will outline what kinds of coverage it offers, including whether you owe coinsurance, copays or some percentage of the cost for a certain kind of care. Many of these costs—other than your actual insurance premiums—also will be qualified HSA expenses.

Putting money in your HSA gives you an account to draw from for those higher upfront costs, as well as your copays and any other qualifying medical expenses and incidentals that insurance doesn't stretch to cover.

A wide variety of expenses are eligible for HSA spending, including (but not limited to):

• Prescription drugs.
• Medical testing supplies.
• Over-the-counter treatments with medicine in them.
• Copayments.
• Coinsurance.
• Doctor visits.
• Treatments like acupuncture and chiropractic are often covered.

And even if your HSA isn't explicitly tied to your vision or dental insurance, you likely can use HSA dollars for checkups, exams, cleanings, surgery, contact lenses, prescription eyeglasses and more.

When you spend on nonmedical expenses, there is a 20% penalty before age 65, so always double-check that an expense is qualified.

See the full list of HSA covered items

The power of tax-free accounts

As you shape a financial plan to get the most out of your money, tax efficiency is key. Nontaxable accounts offer excellent tax advantages, the opportunity to grow your money, and a powerful tool for achieving your financial goals.

Discover the accounts & investments that qualify

When you sign up for an HSA-eligible insurance plan, ask your plan provider how you can take advantage of the HSA option. In most cases, an employer or a plan provider already will have connected with a bank or credit union where you can create your HSA. They'll show you what's needed to start your account.

At that point, you'll want to decide how frequently you want to deposit money into your HSA. Some employers will help you set up a payroll deduction so that the money goes to the HSA directly. If that option isn't available, the financial institution that hosts the HSA can help you make deposits. In either case, pay close attention so that you don't deposit more than the amount allowed per year, or you'll risk a penalty.

Once your HSA arrangements are set, make sure you know how the institution handles paying for medical expenses from the account. You may need to order checks, use an HSA debit card or submit receipts for reimbursement. Then you can start spending the funds whenever you need medical care or products.

Once you retire, you have much more flexibility with your HSA funds and can do more with them.

Once you turn 65, the 20% penalty for spending on nonmedical expenses is lifted, and you can use your HSA money for anything (but note that any nonmedical spending will still likely be subject to income tax).

Additionally, after you turn 65, you can also use HSA funds to pay for long-term care. Long-term care refers to services for those who are chronically ill and require significant assistance or supervision throughout the day. These expenses can be hefty. The average costs of long-term care in the U.S. ranged from $24,700 to $116,000 in 2023.

After age 65, your HSA can fund long-term care services, such as in-home or residential caregiving and medical services, with no penalty.

Dive deeper into using HSAs in retirement and the rules for passing them down

Flexible spending accounts, or FSAs, are similar to HSAs but are considered "use-it-or-lose-it" accounts. If you don't want the high-deductible plan that HSAs often require for eligibility or simply aren't interested in HSAs for other reasons, FSAs are another way you can save for health expenses. Unlike HSAs—which allow contributions to accumulate long-term, be invested and earn interest tax-free—all FSA dollars have to be spent by the end of the calendar year in most cases.

Some FSA plans do offer grace periods and the ability to carry money over, so do your research on specific FSA vs. HSA options.