What Are Health Savings Accounts, and How Do They Work

Health savings accounts (HSAs) provide tax savings for individuals enrolled in a high-deductible health plan (HDHP). Every penny that you contribute to an HSA - up to a maximum amount - reduces your taxable income. You can also invest the unused funds in your account. When you use this money, it's tax free. But it must be used for qualified healthcare expenses.

An HSA offers many tax advantages that can reduce healthcare costs. These accounts offer many benefits, but there's a lot to consider if you want to maximize your savings.

How do HSAs work?

An HSA is a tax-advantaged account that you can use with a qualified HDHP. These plans have a higher deductible than other insurance plans. That means you'll pay more out of pocket before your insurance coverage kicks in. But HDHPs typically offer lower monthly premiums. You can use the funds in your HSA to cover qualified medical expenses, including the money you spend to meet your deductible.

You and your employer can both contribute to your HSA, and then the money can be used for eligible healthcare expenses. HSA funds roll over from year to year, and the money in the account grows with interest.

Who is eligible for an HSA?

If you are enrolled in a qualified HDHP, you must meet other HSA requirements outlined by the Internal Revenue Service (IRS). These include:

• Not claimed as a dependent on someone else's tax return

• Not enrolled in Medicare

• Have health insurance that is allowed by the IRS

How to make HSA contributions

Your employer may offer an HSA, or you can set up your own. If you enroll in an HSA at work, your contributions will be deducted from your paycheck. This is typically how it works:

• Determine the annual limit that you can contribute every year.

• See if your employer plans to contribute funds to your account.

• Decide how much you would like to contribute for the year. You'll need to subtract your employer's contribution from the annual allowed contribution to ensure you don't exceed the limits.

• Set up your HSA contributions with your employer. Money will be withdrawn from your paycheck and automatically transferred to your HSA before your income is taxed.

You can open an HSA at a bank or a brokerage firm if your employer doesn't offer one. You can also set up an HSA if you are self-employed. When you set up an HSA on your own, you can contribute directly to the account and determine the frequency of your contributions.

What are the pros and cons of an HSA?

Here are some of the benefits of an HSA:

• Contributions are tax deductible. If you contribute to an HSA through payroll deductions at your job, the contributions are made pretax. But if you contribute directly to your HSA, it is tax deductible. Instead of getting an up-front tax break, you'll claim a deduction when you file your taxes. Contributions to an HSA lower your taxable income for the year.

• Investment earnings grow tax free. You can invest your HSA money before you use it on medical expenses. You will not have to pay any taxes on the money you earn from these investments. Ask your HSA provider about the rules and restrictions associated with your account.

• Withdrawals are tax free if used to pay for qualified medical expenses. If you're under age 65, you may have to pay a 20% tax penalty and ordinary income tax for nonqualified expenses. When you reach 65 or over, you can withdraw HSA funds for any reason. You'll just have to pay ordinary income taxes on the money.

• Unused funds roll over each year. The funds in your HSA don't expire. Unlike FSAs, there is no risk of losing your money if you don't use it by the end of the plan year.

• HSAs are portable. If you retire or switch jobs, your HSA stays with you. Unlike an FSA, HSAs are not tied to your employer.

• Funds can be used during retirement. You can use your HSA to pay for qualified medical expenses at any age. After you turn 65, you have the flexibility to withdraw money for nonmedical expenses without penalty.

HSAs can help you save money on qualified medical expenses. But there are a few downsides you should consider, including:

• Insurance plan requirements: You must have an HDHP to contribute to an HSA. If you switch to a traditional insurance plan, you won't be eligible to contribute to an HSA.

• High deductibles: Since HSAs are only compatible with HDHPs, you'll have to pay money out of pocket (your annual deductible) before your insurance pays its share of the costs.

• Contribution caps: There is a limit to how much you can contribute each year. The contribution amounts are lower than what you can contribute to retirement accounts.

• Account fees: Depending on your HSA custodian, you may have to pay investment fees or an account maintenance fee.

• Medicare restrictions: You cannot contribute to an HSA after you enroll in Medicare.

• Penalties: If you use your HSA to pay for nonqualified expenses, you'll have to pay a 20% penalty in addition to income taxes. You'll also have to pay a penalty if you contribute more money to your HSA than you're allowed.

What medical expenses qualify for HSA funds?

The money you accumulate in your HSA can pay for eligible medical expenses. When you withdraw your money, you won't have to pay taxes if the money covers qualified medical expenses. Here some some HSA-eligible expenses:

• Adult diapers

• Artificial limb

• Birth control

• Blood pressure monitor

• Blue-light-blocking glasses

• Breast pumps

• Crutches

• Fertility treatment

• Flu shots

• Insulin

• Invisalign

• Lab fees

• Medical-alert bracelets

• Occupational therapy

• Oxygen equipment

• Prenatal vitamins

• Prescription eyeglasses and contact lenses

• Reading glasses

• Vaccines

• Wheelchair

• X-rays

These are only some of the IRS-approved medical, vision, and dental expenses. Your HSA can be used to pay deductibles, coinsurance, and other unreimbursed medical expenses. You can also use the money for monthly period supplies and over-the-counter medications.

The IRS has a complete list of eligible medical expenses on its website. It's best to consult with your tax adviser and plan provider. Make sure you keep receipts and records to confirm eligible expenses.

What is the maximum contribution limit, and how can you make the most of it?

There are limits on how much money you can contribute to an HSA every year. For 2025, you can contribute up to $4,300 for individual coverage and $8,550 for family coverage. Both are increases from 2024. These contribution limits apply to individuals under age 55.

Here's a table that shows maximum HSA contributions for 2025 and 2024:

If you are age 55 or older, you can contribute an extra $1,000 to your HSA. Your spouse can do the same if they meet the age requirements. This is known as a catch-up contribution.

If you contribute too much money to an HSA, you may be subject to a 6% excess contribution penalty. You will continue to pay this penalty every year until the excess contribution amounts are removed from your account. Excess contributions are not tax deductible.

How often are HSA contribution limits changed?

Typically, the IRS provides inflation-adjusted HSA contribution limits every year. The HSA contribution limits for self-coverage increased by $150 for 2025. The limits for family coverage increased by $250.

Here's a table that shows the change in HSA contributions for tax years 2021 to 2025:

Unlike an FSA, the money you contribute to an HSA rolls over every year. Any unused funds can be invested or withdrawn to pay for eligible medical expenses.

Do you have to report your HSA on your tax returns?

You have to report HSA contributions and distributions when you file your taxes. If you made contributions during the year, you should receive Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA information. If you received distributions during the year, you should receive Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA. Your HSA administrator should mail these forms by January 31 of the following year.

You do not need to submit forms 5498-SA or 1099-SA with your tax return. Keep these forms on hand for your records. These forms will provide you with the information you need to complete IRS Form 8889, Health Savings Accounts (HSAs). The IRS requires you to submit Form 8889 anytime you or an employer contribute money to an HSA or if you receive a distribution from it.

What happens to my HSA if I leave my job?

You can take your HSA with you if you leave your job. An HSA is a portable, individually owned account that's not tied to your employer. As long as you maintain coverage under a qualified HDHP, you can continue contributing to the account.

Contributions that were going into your HSA from your former employer will stop if you leave your job. But you can continue to use the funds in your HSA to pay for qualified medical expenses, such as deductibles, copayments, and prescriptions.