HSAs explained: The top benefits of health savings accounts

• Federal tax advantages
• Savings on qualified medical expenses
• Many unreimbursed medical expenses qualify
• Annual rollover
• Others can contribute, including the participant’s employer or family member
• Convenience

An HSA works in conjunction with an HDHP. You can direct portions of your paycheck into the account. Some employers opt to make contributions, too. When your HDHP doesn’t cover a qualified medical expense, you can pay for that cost out of your HSA.

The money you contribute to a health savings account is tax-deductible or pre-tax, and any increase in the value of your account (such as through capital gains and dividends on investments held in the HSA) is free from federal taxes — so long as withdrawals are made for qualified medical expenses (see No. 6). “One of the most important features of an HSA is that it has the potential for triple tax advantages — when money goes into the account, with potential growth and when it comes out,” Goldsmith says.²

Another advantage of an HSA is that you’re not required to take money out of it by any given date, such as the end of the year. As a result, you can save and even invest your balance until you need it. Also, if your employer offers any HSA contributions, you should try to get those funds if possible.

To open an HSA, you must be enrolled in a qualified HDHP, and you cannot be claimed as someone else’s dependent on their tax return. You also cannot contribute to an HSA if you have disqualifying additional medical coverage, such as a general-purpose health flexible spending account (FSA), at the same time.

HDHPs typically come with lower premiums compared with more comprehensive plans, but the insured must meet a high deductible before coverage kicks in. Funds in an HSA can help to cover out-of-pocket healthcare expenses until the plan starts paying.

While HSAs are often offered as a work benefit, you may be able to open an account if your employer doesn’t offer one or if you’re self-employed or unemployed.

Once you create an HSA, you own it. Even if you leave the employer that originally sponsored your HSA, you can keep that HSA or transfer the balance to another HSA — such as one offered by your new employer or an HSA you open yourself. Another plus: If you have an HSA through work but lose your job and continue insurance coverage under COBRA, you can use your HSA to pay your premiums.

You can fund an HSA no matter your income, but you do face annual contribution limits. You have until your federal tax return filing deadline (without extensions) to contribute funds for the current tax year. 

You can put money into an HSA every year that you are eligible for until you enroll in Medicare. After that, you’re no longer allowed to contribute, but you may still use your HSA balance to cover qualified medical expenses with tax-free distributions. (For more on spending your HSA in retirement, see No. 10.) In a year when you’re eligible for only part of the year, special rules apply to determine your annual limit.

You can use an HSA to cover a wide range of routine medical costs, including:

• Qualified out-of-pocket medical expenses you incur before you’ve met your HDHP deductible
• Medical, dental or vision coinsurance and copayments
• Prescription drugs and over-the-counter medications
• Some medical treatments not covered by your insurance, such as visits to a chiropractor
• Some kinds of medical equipment like eyeglasses

HSAs can reimburse these expenses only to the extent that the expenses are not covered by insurance or otherwise paid for. Keep in mind that if you tap your HSA for other reasons, you will owe federal income taxes on the withdrawal and potentially an additional 20% federal tax unless an exception applies. State and local taxes may differ.

In addition to paying for your own qualified medical expenses, you can use money in an HSA to pay for your spouse’s qualified medical expenses and those of a child or any other person you claim as a dependent on your tax return.

While the availability of certain features will differ depending on your provider, for some HSAs you will receive a debit card or checkbook you can use to directly pay for qualified medical expenses. With other providers, you might be able to reimburse yourself for qualified expenses you’ve already incurred by transferring funds from your HSA to your bank account. You can check with your employer or the HSA administrator to learn about the available options.

Some HSAs function as savings accounts only, while others allow you to invest your contributions in a selection of mutual funds or other investment choices, giving your account the potential to grow in value.

If you’re thinking about investing through your HSA, consider your goals. Do you plan to use the account to pay for everyday health expenses in the short term rather than saving it for future medical costs? If so, then you may want to keep those funds in cash or investments that offer easy access to cash.

Anticipating that you won’t be using cash in the account anytime soon? Then consider mutual funds or other investment choices that may be more appropriate for the long term. Be aware that your account balance might have to reach a certain amount before your provider allows you to invest it, and you may need to maintain a certain cash balance. Also, note that investing in securities involves risks, with the potential for investments to lose value.

Yes! Starting an account while you’re in good health could help you in retirement when your medical bills are likely to increase. Withdrawals for qualified medical expenses remain tax-free, and when you are eligible for Medicare (generally age 65 or older), you can use an HSA to pay for Medicare premiums with tax-free withdrawals. However, withdrawals to pay for Medicare supplemental policies are generally not tax-free.

Plus, after you reach age 65, you can even use your HSA to pay for expenses beyond healthcare. You will need to pay regular federal income taxes on those non-qualified withdrawals, but the 20% additional tax (see No. 6) no longer applies. In effect, you can tap HSA funds from age 65 onward as you would from an IRA; the federal tax implications are the same. State and local taxes may differ.

One potential downside is that you must be enrolled in a health insurance plan with a high deductible to contribute to an HSA, leaving you responsible for more costs before coverage kicks in. (If you prefer a plan with a lower deductible, you wouldn’t be eligible to fund an HSA.) Or you might have other savings priorities — like building an emergency fund — that leave little room in your budget for funding yet another savings account. Or you might decide you’d rather devote any spare cash to investing in an IRA or other account dedicated solely to retirement.

An HSA can be a useful tool for addressing the high costs of healthcare. “In today’s healthcare market, we all need to evaluate our short- and long-term needs as they relate to healthcare coverage,” Goldsmith says. “If you consider the cost of insurance in combination with the potential savings provided by an HSA, you may be better positioned to meet your medical needs — and possibly have money left over to help you meet your other goals.”