What Are the Pros and Cons of a Health Savings Account (HSA)? (2024)

A health savings account (HSA) is essentially a personal savings account that can be used only for medical expenses. To be eligible, you must be enrolled in a high-deductible health plan (HDHP). HSAs have tax advantages that result in many people using them as retirement plans, alongside their 401(k) or IRA accounts.

Contributions to an HSA are made with pretax dollars. This means that you won’t pay income tax on the money that you put directly into your HSA, and you'll save on income taxes for the year.

On the other hand, the money that you put into your HSA is expensive to access once it’s already in the account if it is not used properly. You’ll owe income taxes plus a 20% penalty if you withdraw funds from your HSA for non-qualified expenses before you turn age 65.

Understanding Health Savings Accounts (HSAs)

A health savings account (HSA) is a tax-exempt savings account that is available only to people who have high-deductible health insurance plans. The money can be used only to pay for qualified medical expenses. If the money is spent for any other purpose, the account holder has to pay income tax on the withdrawal plus a 20% tax penalty (unless the person is age 65 or older, in which case the penalty is waived).

Who Is Eligible for an HSA?

People with an HDHP can open an HSA. The two are usually paired together, so you’ll be offered an HSA when you take out a qualifying plan.

You must also meet the eligibility standards set out by theInternal Revenue Service (IRS). An eligible individual is someone who:

• Has a qualified HDHP
• Has no other health coverage
• Is not enrolled inMedicare
• Is not claimed as a dependent on someone else’s tax return

Is It Worth It to Have an HSA?

It can be worth it to have an HSA for the tax advantages alone. The money that you contribute to an HSA is tax-free, so you lower your tax bill by routing money that you can use for medical expenses through such an account. Your employer won’t withhold income taxes on this money.

On the downside, an HSA is open only to people with HDHPs, and a high-deductible plan is not for everyone. The financial benefit of an HDHP’s lower premium and higher deductible structure depends on your personal situation. Generally, healthy people with no ongoing issues that require regular treatment may find them adequate.

Does HSA Money Expire?

The money you put in your HSA has no expiration date and will stay in your account forever. This means that unspent money in an HSA rolls over at the end of the year and remains available for future health expenses.

This is unlike flexible spending accounts (FSAs), which are available to many through their employers but which are strictly “use it or lose it.”

What Can HSA Funds Be Used for?

Money that you withdraw from your HSA isn’t taxed as long as it is used for a qualified medical expense. The list of permitted expenses is quite long and includes deductibles, dental services, vision care, prescription drugs, co-pays, psychiatric treatments, and other qualified medical expenses not covered by a health insurance plan.

Insurance premiumsdon’t count as a qualified medical expense with some exceptions: the premiums are forMedicare or other healthcare coverage for people 65 or older; for healthcare continuation coverage (COBRA) while receiving unemployment compensation, or forlong-term care insurance, subject to annually adjusted limits.

Premiums for Medicare supplemental or Medigap policies are not treated as qualified medical expenses.

If you use your HSA to pay for anything other than a qualified medical expense, that amount is subject to both income tax and an additional 20% tax penalty unless you are age 65 or older. In that case, you just have to pay income tax on the amount withdrawn.

Annual Contribution Limits

For 2024, the limit is $4,150 for individuals and $8,300 for family coverage for families plus an additional $1,000 catch-up contribution for anyone age 55 or older by the end of the tax year.

Advantages of HSAs

Access to an HSA is intended to take some of the stress out of unexpected health costs. But these accounts have other advantages.

Many Expenses Qualify

Eligible expenses include a wide range of medical, dental, and mental health services. They are explained in detail in IRS Publication 502, Medical and Dental Expenses.

Others Can Contribute

Contributions can come from you, your employer, a relative, or anyone else who wants to add to your HSA. Employers choose whether or not to contribute.

Pretax Contributions

Contributions are made with pretax dollars through payroll deductions by your employer. In other words, your employer won’t withhold taxes on these dollars.

That means that the money is not included in your gross income and is not subject to federal income taxes. In most states, contributions are not subject to state income taxes.

Tax-Deductible After-Tax Contributions

If you make contributions with after-tax dollars, you can deduct the money from your gross income on your tax return, reducing your tax bill for the year. For example, if you’re an individual under the age of 55, your maximum allowed contribution to an HSA is $4,150 in 2024.

So, if you deposit only $2,600 into your HSA through payroll deductions by the end of 2023, you may choose to deposit an additional $1,550 to further lower yourtax liability. You generally have until the IRS tax filing deadline to contribute.

Tax-Free Withdrawals

Withdrawals from your HSA are not subject to federal (and in most cases, state) taxes if you use them for qualified medical expenses.

Meanwhile, the balance in an HSA can be invested. You can purchase stocks, bonds, and other types of assets to boost your potential returns. Most financial advisors will strongly suggest conservative investments such as U.S. Treasury bonds. This account is, first of all, a nest egg for unexpected medical expenses.

Tax-Free Earnings

Any interest or other earnings on the money in the account is tax free. Most HSAs earn a minimal amount of interest, less than 0.1%.

Annual Rollover

If you have money left in your HSA at the end of the year, it rolls over to the next year.

This is a big advantage over FSAs, which normally can only be carried over in an amount up to $550 or 2½ months into the following plan year.

Portability

The money in your HSA remains available for future qualified medical expenses even if you change health insurance plans, leave for a different employer, or retire.

Essentially, your HSA is a bank account in your name, and you decide how and when to use the funds.

Convenience

Most HSAs issue a debit card so you can pay for prescription medications and other eligible expenses. If you wait for a bill to come in the mail, you can call the billing center and make a payment over the phone using your HSA debit card.You can also reimburse yourself out of an HSA if you have paid a medical bill with another form of payment.

Disadvantages of HSAs

If you qualify for an HSA, there are some disadvantages to consider.

High-Deductible Requirement

An HDHP, which you are required to have to qualify for an HSA, can put a greater financial burden on you than other types of health insurance. Even though you will pay less in premiums each month, it could be difficult—even with money in an HSA—to come up with the cash to meet the deductible for a costly medical procedure.

This is something to consider for anyone who knows they will have hefty medical bills in a particular plan year.

Pressure to Save

Some people may be reluctant to seek healthcare when they need it because they don’t want to spend the money in their HSA accounts.

Taxes and Penalties

If you withdraw funds for non-qualified expenses before you turn age 65, you’ll owe income taxes on the money plus a 20% penalty. Once you’re 65, you’ll owe taxes but not the penalty.

This can be hard on a person who faces an unexpected expense that is anything but medical. They have saved the money but can't access it without taking a financial hit.

Recordkeeping

You must keep receipts to prove that your withdrawals were used for qualified health expenses. This will be necessary if you are audited by the IRS.

Fees

Some HSAs charge a monthly maintenance fee or a per-transaction fee, which varies by institution. While typically not very high, the fees are almost certainly higher than any interest that the account may earn and cut into your bottom line.

Sometimes these fees are waived if you maintain a certain minimum balance.

The Bottom Line

For those who choose high-deductible health plans (HDHPs), an HSA has real advantages. It can offset your medical costs, reduce your taxes, and give you a long-term tax-advantaged savings account. But an HDHP isn't the best option for everyone, and having one is the only way to get access to an HSA account.