What is a health savings account (HSA)?

An HSA is a savings account for the sole purpose of paying allowable healthcare expenses. But to qualify, you must have a particular type of health insurance, which I’ll cover in a moment.

An HSA is my favorite tax-advantaged account because you can use it to pay qualified healthcare expenses on a pre-tax basis. However, you can also spend it on non-qualified expenses, like everyday bills or a vacation, after your 65th birthday. 

It’s a clever, legal way to pay less tax, save more, and invest for the future. But HSAs have strict rules you must follow or pay a hefty 20% penalty.

Who qualifies for an HSA?

I mentioned that you need a particular type of health insurance to qualify for an HSA, which is an HSA-qualified, high-deductible health plan (HDHP). Your deductible is the amount you must pay out-of-pocket for covered expenses before your insurance benefits begin each year.

You can buy an HSA-eligible health plan on your own, such as through Healthcare.gov or HBG Solo (if you’re self-employed). Or you might have access to one through an  employer’s group insurance plan. If you enroll in an HSA through your job, you own the account and can take it with you if you leave your employer for any reason.

In other words, you don’t need permission from an employer or the IRS to set up an HSA, and it stays with you if you change jobs or become unemployed. Even if you lose HSA-eligible insurance, you can continue spending your HSA balance but can’t make new contributions.

Should I purchase an HSA-eligible health plan?

While you might think it’s better to have a lower deductible and pay less out-of-pocket, having a higher deductible reduces your monthly insurance premiums. Deductibles and premiums have a seesaw relationship because increasing one makes the other go down.

Having an HSA-eligible health plan means you could have high out-of-pocket costs. So, they’re not the right choice for everyone. In general, purchasing an high-deductible health plan may be wise when you’re in relatively good health and aren’t likely to spend the full deductible each year.

What are the tax benefits of an HSA?

If you’re eligible for an HSA, you receive three powerful tax benefits that aren’t available with any other tax-advantaged account.

1. Your contributions are tax-deductible up to an annual limit, reducing your taxable income for the year. 
2. Your balance grows tax-deferred with no taxes due on annual interest income or investment earnings.
3. Your withdrawals can be spent tax-free on qualified healthcare expenses.

The beauty of an HSA is that contributions are deductible on your tax return even if you don’t itemize deductions. The funds can earn interest, or you can invest some or all of them using a menu of options, such as mutual funds, depending on your provider. Your original contributions and earnings are tax-free if you take distributions to pay qualified healthcare expenses.

HSA contributions can come from you or someone else, such as a family member or employer. Some company benefits include regular HSA deposits, similar to retirement plan matching funds. Employer contributions aren’t included in your taxable income, which is a fantastic benefit.

Depending on your income tax rate, using an HSA to pay qualified healthcare expenses tax-free could mean getting a 20% to 30% discount on those costs. Over your lifetime, that can add up to huge savings!

Like a retirement account, you should never put money in an HSA that you might need for everyday expenses. Until you turn 65, you can only use HSA funds for qualified, unreimbursed healthcare expenses or pay a penalty. For instance, using an HSA for non-qualified expenses, like rent or groceries, means you must pay income tax plus an additional 20% penalty on withdrawn amounts.

READ ALSO: 2024s big savings and retirement rule changes

In addition to its terrific tax benefits, using an HSA comes with more advantages.

• Your funds remain in the account indefinitely with no penalty if you don’t spend them.
• You can spend funds on qualified healthcare expenses for you, your spouse, and your dependents (including children and parents).
• You own the account and decide how much to save up to an annual limit.
• You can keep or transfer funds to a new HSA if you change employers, switch health plans, or become unemployed.
• You can fund an HSA for the first time using a tax-free IRA rollover once in your lifetime, up to the annual contribution limit.

How much can you contribute to an HSA?

For 2023, you can contribute up to $3,850 to an HSA if you have individual health coverage or $7,750 with a family plan. If you’re over 55, you can contribute an additional $1,000 catchup amount with either type.

For 2024, the HSA contribution limit for individual coverage increases to $4,150, and the family plan cap goes up to $8,300. The $1,000 catchup contribution remains the same.

You can make tax-deductible contributions anytime during the year, even up to April 15 for the previous tax year. But you’re never required to contribute to an HSA in any year.

Over-contributing to various tax-advantaged accounts isn’t allowed, but can be easy to do by mistake. Laura reviews the contribution limits for various accounts and how to correct an excess so you avoid costly penalties. Listen in this player:

How can you use an HSA in retirement?

I mentioned that after age 65, you can spend an HSA on non-qualified expenses without paying a 20% penalty. Be advised, though, that you must pay income tax on those withdrawn amounts.

That means an HSA becomes similar to a traditional retirement account if you keep it long enough. Your withdrawals are subject to income tax, and you can spend them any way you wish. That’s a great reason to max out an HSA every year, even if you don’t expect many healthcare expenses. 

What are HSA-qualified medical expenses?

Understanding how to spend it is critical once you’ve opened an HSA and have a balance. Qualified expenses include a wide range of healthcare costs you incur until you meet your annual deductible or aren’t covered by insurance.

The IRS says HSA-qualified expenses must pay for healthcare services, equipment, or medications. There are many covered expenses that you might not expect, and I’ll review some of them.

14 surprising HSA-qualified healthcare expenses

There are hundreds of HSA-qualified healthcare expenses; you can see the complete list in IRS Publication 502, Medical and Dental Expenses. Here are 14 that may surprise you:

1. Over-the-counter medications

You can buy non-prescription medications, like pain relievers, allergy medications, cold and flu medications, sleep aids, eye drops, and menstrual products entirely tax-free.

2. Dental care

Going to the dentist is also covered for routine cleanings and the prevention of dental disease. You can use your HSA for services like fluoride treatments, X-rays, fillings, extractions, dentures, and braces. Teeth whitening is not a qualified expense, nor is any cost or therapy that’s purely cosmetic. Although some might consider them primarily cosmetic, artificial teeth are an HSA-eligible expense. 

3. Vision care

HSAs can be used to pay for contact lenses and glasses, including prescription sunglasses. Any out-of-pocket costs you have to correct your vision, such as LASIK or the removal of cataracts, can be paid for using HSA funds. If your sight or hearing is impaired, you can use it to purchase and care for a guide dog or other service animal.

4. Hearing care

You can get hearing tests and purchase hearing aids and batteries using HSA funds.

5. Chiropractic care

All chiropractic care is HSA-qualified, even if your insurance doesn’t cover it. That means you can explore this alternative for pain relief before you get medication or surgery.

6. Acupuncture

Even if your health insurance doesn’t cover acupuncture, you can use your HSA to pay for it.

7. Birth control

If your doctor prescribes birth control pills, you can use your HSA to pay for them. 

8. Fertility enhancement

You can use an HSA to pay for any treatment to overcome an inability to have children, such as in vitro fertilization. Once you’re a parent, you can also spend it on breast pumps and supplies that assist lactation. Or you can use an HSA to go in the opposite direction and pay for sterilization or legal abortion.

9. Drug and alcohol addiction treatment

Any amount you pay for yourself or a family member for inpatient treatment at a drug rehabilitation center, including meals and lodging, is HSA-qualified. You can also pay for transportation to and from Alcoholics Anonymous meetings in your community, assuming a medical provider has deemed AA attendance medically necessary for you.

10. Care from a psychologist or psychiatrist

You can use HSA funds for the costs to support yourself or a family member who you claim as a dependent through the treatment of a mental condition or illness. You can use HSA funds to pay for a patient’s treatment at a health institute if a physician prescribes treatment to alleviate a physical or mental disability or illness.

11. Home improvements

Any special equipment or improvements installed in a home to care for yourself or your dependent family members can be paid for with an HSA if their purpose is medical care. These might include constructing entrance ramps, widening doorways, installing lifts, or lowering cabinets and sinks. Another capital expense that’s HSA-qualified is removing lead-based paint in a home you own or rent.

12. Transportation and travel

Getting to and from medical care, such as on a bus, taxi, train, plane, or ambulance, can be paid for with HSA money. This rule includes regular visits to see an ill family member if visits are recommended as treatment. You can include lodging, but not meals, when you travel to another city for medical purposes.

If you use your vehicle to get to medical services, you can use HSA money to cover certain out-of-pocket costs, including gas, oil, tolls, and parking fees. But you can’t cover general vehicle maintenance or insurance costs.

13. Long-term care

You can pay long-term care costs like being in an assisted living facility or receiving in-home nursing care.

14. Medical equipment

Equipment, including wheelchairs, walkers, crutches, and other equipment necessary for daily living, can be paid for with an HSA.

How do you open and fund an HSA?

If you qualify for an HSA, they’re available at many local institutions or online platforms, like Lively. Accounts are convenient and offer paper checks, debit cards, and online banking. Receiving unique tax advantages and flexibility makes an HSA one of the best tools for managing healthcare costs now and in the future for you and your family.