An HSA lets you set aside pre-tax money to pay for medical expenses now or later

A Health Savings Account (HSA) is a bank account where you deposit money before taxes are taken out of your paycheck. That money sits there until you need it to pay for medical bills — doctor visits, prescriptions, dental work, vision care, and many other health costs. The money you don't spend stays in the account and grows year to year. You own the account, not your employer, so it goes with you if you change jobs.

The main advantage is tax savings. Money you put into an HSA is not taxed when you earn it, and money you withdraw to pay for medical expenses is not taxed when you spend it. If you invest the money and it grows, that growth is also not taxed. This is different from a regular savings account, where you pay taxes on the interest you earn.

To open an HSA, you must be enrolled in a high-deductible health plan (HDHP) — a type of health insurance with lower monthly premiums but higher out-of-pocket costs before insurance kicks in. You cannot have an HSA if you are on Medicare, covered by a spouse's non-HDHP plan, or claimed as a dependent on someone else's taxes.

Key Takeaways

  • You contribute pre-tax money to an HSA through payroll deduction or direct deposit, and you can only open one if you have a high-deductible health plan.
  • Annual contribution limits are set by the IRS and vary based on whether you have individual or family coverage; for 2024, the limit is $4,150 for individual coverage and $8,300 for family coverage.
  • You can spend HSA money on a wide range of medical expenses including deductibles, copays, prescriptions, dental, vision, and mental health care without paying taxes on the withdrawal.
  • Money left unspent in your HSA rolls over to the next year and can be invested to grow; there is no "use it or lose it" deadline like some other health accounts.
  • After age 65, you can withdraw HSA money for any reason without penalty, though non-medical withdrawals are taxed as regular income.

How to set up an HSA and put money in

If your employer offers an HDHP, they usually offer an HSA through the same insurance company or a partner bank. During open enrollment, you choose the HDHP and then open the HSA account. You decide how much to contribute each year, up to the IRS limit. For 2024, the limit is $4,150 if you have individual coverage or $8,300 if you have family coverage. If you are 55 or older, you can add an extra $1,000 per year.

Most people contribute through payroll deduction — the money comes out of your paycheck before taxes are calculated, so you see the tax savings immediately. If you are self-employed or your employer does not offer an HSA, you can open one at a bank or financial institution and contribute on your own. You then deduct the contribution on your tax return when you file.

You do not have to contribute the full limit. You can put in $50 a month or $2,000 a year — whatever fits your budget. The account is yours to manage, and you can change your contribution amount during open enrollment or if you have a may have access to life event, such as a job change or birth of a child.

What medical expenses you can pay with HSA money

HSA money can cover a long list of medical costs. The most common are deductibles, copays, and coinsurance on your health plan. It also covers prescriptions, dental care (cleanings, fillings, root canals, orthodontics), vision care (eye exams, glasses, contacts, surgery), mental health counseling, and physical therapy. You can use it for medical equipment like crutches, wheelchairs, or blood pressure monitors, and for over-the-counter items like pain relievers, allergy medicine, and bandages if a doctor prescribes them.

Some expenses do not count. Cosmetic procedures, gym memberships, and vitamins without a prescription are not covered. Health insurance premiums generally do not count, except for COBRA continuation coverage, long-term care insurance, or premiums you pay while receiving unemployment benefits.

Keep receipts and documentation for every HSA withdrawal. The IRS can audit your account and ask you to prove that money was spent on medical expenses. If you withdraw money for a non-medical reason, you pay income tax on it plus a 20 percent penalty — unless you are 65 or older, in which case you pay income tax but no penalty.

How HSA money grows and what happens to unused funds

Unlike a flexible spending account (FSA), an HSA has no "use it or lose it" rule. Money left in the account at the end of the year stays there. You can let it accumulate year after year, building a reserve for future medical expenses or retirement.

Most HSAs allow you to invest the money in mutual funds or other investments, similar to a 401(k). If you invest it, the money can grow through investment returns, and that growth is not taxed. Some HSAs require you to keep a minimum balance (often $1,000 to $2,500) in cash before you can invest the rest. Check your account provider's rules.

If you leave your job, your HSA stays with you. You own it, not your employer. You can roll it to a new HSA at a different bank, or keep it where it is and continue to manage it. If you lose HDHP coverage — for example, by switching to a regular health plan — you can no longer contribute new money, but you can still withdraw money for medical expenses without penalty.

HSA withdrawals and how to use the money

You can withdraw money from your HSA whenever you need it to pay a medical bill. Some HSAs issue a debit card linked to the account, so you can pay at the doctor's office or pharmacy directly. Others require you to pay out of pocket and then submit a receipt to get reimbursed. A few HSAs let you do both.

There is no deadline to withdraw money for a medical expense. You can pay a bill today and reimburse yourself from the HSA years later, as long as you have the receipt. This is useful if you want to let the money grow through investments and only withdraw it in retirement.

Withdrawals for medical expenses are never taxed and never penalized, no matter how old you are or how long the money has been in the account. The only requirement is that you have documentation showing the money was spent on a covered medical expense.

Tax benefits and how much you actually save

The tax savings depend on your income and tax bracket. If you contribute $4,150 to an HSA and you are in the 22 percent federal tax bracket, you save about $913 in federal taxes. You also save state and local income taxes in most states, plus 7.65 percent in payroll taxes (Social Security and Medicare), so the total savings can be 30 to 40 percent of what you contribute.

Example: You contribute $200 per month ($2,400 per year) to an HSA. If your combined federal, state, and payroll tax rate is 35 percent, you save $840 per year. That is money that stays in your account instead of going to taxes.

The tax advantage is one reason HSAs are popular with people who expect to have medical expenses. Even if you do not use the money right away, the tax-free growth over decades can add up significantly, especially if you invest it.

HSA rules after age 65 and in retirement

Once you turn 65, the rules change. You can withdraw money from your HSA for any reason — medical or not — and you only pay income tax on non-medical withdrawals. You do not pay the 20 percent penalty. This makes an HSA function like a traditional retirement account after 65, similar to an IRA or 401(k).

Many people use this feature to let their HSA grow untouched during their working years, then use it to pay for medical expenses in retirement without penalty. Since retirees often have significant medical costs, an HSA can be a powerful tool to cover those expenses with pre-tax money.

If you are on Medicare, you can no longer contribute to an HSA, but you can still withdraw money from an existing account for medical expenses. Medicare premiums themselves do not count as covered expenses, but copays, deductibles, and other out-of-pocket costs do.

Frequently Asked Questions

Can I use HSA money to pay for my spouse's medical expenses?

Yes, as long as your spouse is claimed as a dependent on your tax return. You can use HSA money for medical expenses of your spouse, children, and any other dependents, even if they are not on your health plan. Keep receipts to document the expenses.

What happens to my HSA if I switch to a regular health plan?

You can no longer contribute new money to the HSA, but the money already in the account stays there. You can continue to withdraw it for medical expenses without penalty or taxes. If you switch back to an HDHP later, you can resume contributions.

Can I withdraw HSA money to pay for health insurance premiums?

Generally no, with three exceptions: COBRA continuation coverage, long-term care insurance, and health insurance premiums paid while you are receiving unemployment benefits. Regular health insurance premiums, including Medicare premiums after age 65, do not count as covered expenses.

Do I have to use my HSA money every year or does it roll over?

HSA money rolls over every year with no limit. There is no "use it or lose it" deadline. You can let it accumulate for decades, invest it, and withdraw it whenever you need it for medical expenses. This is one major advantage over flexible spending accounts.

What if I withdraw money from my HSA for a non-medical expense before age 65?

You pay income tax on the amount withdrawn plus a 20 percent penalty. For example, if you withdraw $1,000 for a non-medical reason and you are in the 22 percent tax bracket, you owe $220 in income tax plus $200 in penalty, for a total of $420. Keep receipts to prove expenses are medical if you are audited.