What is an HSA?

Medical care in the United States is expensive, as just about anyone could tell you. The total cost of medical care in the U.S. is now $11,172 per person, per year, although this includes costs paid for by insurance plans and Medicare. 

Even if you have decent insurance through your employer, out-of-pocket costs for medical care and prescriptions can really add up. The average American now spends $1,650 per year on out-of-pocket medical expenses, and that’s with insurance. 

Fortunately, there’s a little-known hack that can help decrease the burden of medical costs. It’s called a health savings account, or HSA. It’s kind of like a retirement account, but for medical expenses. 

This article explains:

• How to get a health savings account

• HSA benefits

• What you can use an HSA for

• Using an HSA in retirement

What is an HSA? 

HSA stands for health savings account. 

An HSA is a type of savings account that can be used to put money aside tax-free. The funds can then be used later for qualifying medical expenses. 

HSAs may be offered through your employer if they have a qualifying health insurance plan. Or, you may be able to open an HSA at a bank or brokerage, as long as you have a qualifying medical plan yourself (more on this later). 

HSAs often come with debit cards that can be used to pay for qualifying medical expenses. Some plans also let you reimburse yourself for expenses that you paid for directly. 

Basically, if you expect to have medical expenses ever in the future, contributing to an HSA allows you to set aside money to pay for those expenses — and the IRS offers you generous tax benefits for doing so. 

Benefits of a health savings account

The main benefit of an HSA is that any money you contribute to the account is pre-tax, meaning it’s deducted from your income for federal tax purposes. 

For example, if you are in the 22% tax bracket and contribute $3,000 to your HSA this year, that could save you roughly $660 in income taxes. 

And that’s not the only benefit!  There are three other primary HSA benefits to be aware of: 

• Contributions are tax deductible/pre-tax. Every dollar you put into your HSA is another dollar that won’t be subject to federal income tax. 

• Money is able to grow tax-free. HSA funds can be invested (more on this later), and there is no tax due for dividends earned or capital gains from selling profitable investments (as long as the funds are used for medical expenses).

• Money used for qualifying medical expenses is tax-free. When you eventually withdraw the funds, you won’t owe any taxes on them (or on the profits from investment), as long as they’re used to pay for qualifying medical expenses. 

Are HSA contributions tax deductible? 

There is some confusion about pre-tax vs. tax deductible and what that all means, but the answer is: yes, HSA contributions are tax deductible.

If you have an HSA through your employer, money may be taken out of your paycheck each month to go directly into your HSA (or your employer may contribute some themselves). This is called “pre-tax” money, because no income tax is withheld and you won’t pay any taxes on those funds.

If you have an HSA through a bank or brokerage, income tax will still be withheld from the money you put into the HSA. But, at the end of the year when you file your taxes, you’ll be able to deduct your HSA contributions (making them tax deductible). 

The end result is the same either way, it’s just a matter of terminology. 

Do I qualify for an HSA? 

Okay, here’s the tricky part: Not everyone qualifies for an HSA. In fact, many people don’t.

To open an HSA, you need to have an HSA-eligible health insurance plan. 

What is HSA-eligible in this case? You must have a high-deductible health insurance plan that meets the following qualifications:

• The plan must have a deductible of at least $1,400 for an individual or $2,800 for a family

• The plan must have yearly out-of-pocket expenses of less than $7,050 for an individual or $14,100 for a family

So basically, the plan needs to have a relatively high deductible and a high (but not too high) annual out-of-pocket max.

And unfortunately, many plans don’t qualify, even if they look like they should. This is because the IRS requires that “[the] plan may not provide benefits for any year until the deductible for that year is met." 

Many plans with high deductibles that would normally qualify offer side benefits — like prescription drug perks — making them ineligible for HSA coverage.

The easiest way to check if your plan is HSA eligible is to contact the plan provider. You could ask your HR department at work, or reach out to the insurance company directly. 

HSA contribution limits & rules

HSA account holders can only contribute a certain amount each year — but they can do so every year, whether they have any medical expenses or not.

For 2022, the HSA contribution limits are as follows:

• $3,650 for self-only coverage (one person)

• $7,300 for family coverage (more than one person)

Money contributed to an HSA “rolls over,” meaning it stays in the account in all future years until it is used. This is different from a flexible spending account (FSA), where funds must be used in the same tax year in order to reap the benefits. 

What can you use HSA money for?

Once money is put into an HSA, it will stay in the account as cash, or be invested (depending on your preferences and what the account provider allows).

From there, funds can only be withdrawn to pay for qualifying medical expenses.

You can technically withdraw the funds for other uses, but there’s an HSA withdrawal penalty of 20%, plus the applicable income tax. In other words, it’s wise to only use HSA funds for qualifying medical expenses. 

So what is an HSA qualifying expense, and what isn’t? 

What qualifies

• Insurance co-pays and out of pocket medical expenses

• Doctor and specialist visits

• Medical care

• Dental care

• Prescription drugs

• Over-the-counter medications

• Menstrual care products

• Everything else that qualifies as a medical or dental expense (see IRS Publication 502)

What doesn’t qualify

• Health insurance premiums (the monthly amount you pay for health insurance)

• Everything else that’s not a legitimate medical or dental expense

Basically, anything that is a reasonable and legitimate medical or dental expense should qualify — with the exception of health insurance monthly premiums, which do not qualify. 

When will my HSA funds be available? 

Funds can be withdrawn as soon as they’re deposited and the transaction clears. But again, unless you use them for medical expenses, there will be a tax penalty. 

More information on HSA rules and regulations can be found on this IRS page. 

Using an HSA in retirement

HSA accounts offer significant benefits for retirement planning. 

Many of us will have medical expenses in our later years. And having HSA funds set aside provides peace of mind (and valuable tax benefits).

You can contribute to an HSA up until the point when you qualify for medicare (65 currently). And remember, funds can be invested in the stock market and allowed to grow over time, just like with a retirement account. 

Plus, a little-known perk of an HSA is that once you turn 65, you can withdraw funds for any purpose without the 20% tax penalty. You will still pay taxes on the withdrawal, but you won’t owe a penalty.

In this way, an HSA functions much like a 401(k). But it’s even better, because if you do end up using the funds for medical care, the withdrawals are tax-free. 

Wrapping up

Using an HSA can be a beneficial part of your personal finance strategy. 

If you qualify for one, it’s wise to sign up as soon as possible and start contributing. For the biggest benefit possible, think about investing the funds in your HSA. 

And if paying off debt is on your financial to-do list, look into the Tally†. Tally is a personal finance app that may help qualifying Americans pay off their credit card debt faster. 

†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% - 29.99% per year. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.