Health insurance premiums and costs are rising each year and causing financial stress for many individuals and families. If you’re looking for ways to save money on medical expenses, a health savings account (HSA) may be an effective tool. Around 34 million people use them to save and pay for medical expenses.1 You might have heard of HSAs, but what exactly are they, and are they suitable for your needs?

Here's a closer look at the rules, benefits, pros and cons of contributing to HSAs to help you decide if it’s a good option for you.

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HSA benefits include tax advantages, flexibility and the potential for long-term savings.

 

What's an HSA?

HSAs are savings accounts that let you set aside pre-tax income to pay for qualified medical expenses. You may contribute to an HSA if you have an HSA-eligible high-deductible health plan (HDHP). With a high-deductible plan, in exchange for lower monthly premiums, you pay more initial out-of-pocket medical costs before your insurance coverage kicks in. You can use your HSA to pay for these out-of-pocket costs and other qualified medical expenses now and in the future.

Think of an HSA as a savings account for medical expenses only. You can use the funds in your account to pay for expenses such as doctor visits, prescriptions and over-the-counter medicines, home medical supplies, glasses and contact lenses, and much more. Your employer may also contribute funds to the account, and you may have the option to invest the funds for additional growth potential.2

Benefits of HSAs

HSAs offer numerous advantages that can help you save money and be better prepared for future medical costs. These include:

  • Tax advantages: HSAs offer a triple tax benefit. Contributions to your HSA are tax-deductible, interest or other earnings grow tax-free, and withdrawals for qualified medical expenses are also tax-free. This provides a powerful incentive to save for health care expenses while also reducing your taxable income.
  • Flexibility: HSAs are incredibly flexible. As an account holder, you can use the funds for a wide range of qualified medical expenses, and you also have the flexibility to change your contributions and investments over time.
  • Portability: HSAs are portable, meaning they belong to the individual, not the employer. This allows you to keep your HSA account and contributions even if you change jobs or health plans.
  • Investment potential: Many HSA providers provide investment options that allow account holders to potentially grow their savings over time. This is an important detail, because investments in HSAs can potentially outpace the rate of healthcare cost inflation.
  • No use-it-or-lose-it rule: Unlike flexible spending accounts (FSAs), HSA funds roll over from year to year, giving you the opportunity to accumulate savings for future healthcare expenses.
HSA rules and limitations

HSAs are valuable financial tools, but there are rules and limitations you’ll have to keep in mind:

  • Eligibility: To open and contribute to an HSA, you must be enrolled in a qualified high-deductible health plan. You cannot be covered by other non-HDHP health insurance, including Medicare.
  • Contribution limits: The IRS limits how much you can contribute to your HSA each year, and it’s subject to change. Be sure to check the current guidelines for the latest limits.2
  • Qualified medical expenses: HSA funds can only be used for qualified medical expenses as defined by the IRS. A list of qualifying expenses can be found online or through your insurance provider.
  • Penalties: If HSA funds are withdrawn for non-qualified expenses before age 65, a 20% penalty applies in addition to income tax. After age 65, withdrawals for non-medical expenses are subject to income tax, but not the penalty.
  • Investment options: While some HSA providers offer investment options, they may not be as diverse as those available in traditional retirement accounts.
Is an HSA right for you?

HSA benefits include tax advantages, flexibility and the potential for long-term savings. However, they are generally most suitable for people who can handle the financial requirements of a high-deductible health plan and who are committed to saving for health care expenses.

Understanding the rules and evaluating your personal financial situation is essential when considering an HSA as part of your overall financial strategy. Be sure to read your benefits materials or consult with a financial professional before any making decisions.