What Is An HSA?: How Health Savings Accounts Work

High health care expenses are a harsh reality for many people, so it’s natural to look for ways to save money without compromising your quality of care. A health savings accounts (HSA) can be a valuable financial tool to help navigate medical expenses more efficiently because of their substantial tax advantages. Learn what an HSA is and how to use one to reduce your overall health care costs.

What Is A Health Savings Account (HSA)?

An HSA allows you to set aside pretax dollars to pay for qualified medical expenses, but they must be paired with a high-deductible health plan (HDHP). You can invest the money in the account, and the IRS does not tax the earnings.

An HSA often supplements an HDHP, a type of health insurance plan that costs less per month. However, due to the high deductible, you need to pay more out of pocket with an HDHP before your insurance coverage kicks in. The HSA is like a companion account that allows you to save pretax dollars to pay for medical expenses not covered by your HDHP, lowering your taxable income.

What Is A High-Deductible Health Plan (HDHP)?

An HDHP offers low monthly premiums, which can save you money throughout the year compared with other types of plans. However, you will need to cover the costs of your medical care out-of-pocket until you reach the deductible specified by your plan. Also, even once you reach your health insurance deductible, you still might be responsible for copays or coinsurance.

The IRS requires HSA-eligible plans to have minimum and maximum annual deductibles of these amounts:

Who Is Eligible For An HSA?

An HSA is an important feature available to people with an HDHP for health insurance coverage. With an HDHP, you must pay out-of-pocket for any health care services you receive until you reach your deductible, except for certain preventative care services mandated by the Affordable Care Act.

An HSA is a helpful component of these plans because it allows you to save money tax-free for these larger payments for medical expenses until you reach the deductible. However, you may owe penalties if you use the funds for anything other than qualified medical expenses. The great thing is, though, that the money in the HSA belongs to you, even if you switch jobs or choose another health plan in the future.

To be eligible, you cannot be covered by any other non-HDHP health insurance plan, be claimed as a dependent on someone else's tax return, or be enrolled in Medicare.

How Does An HSA Work?

An HSA is a financial tool designed to help you save for medical expenses while enjoying several tax benefits. You can make pretax contributions, have tax-free interest and earnings, and make tax-free withdrawals for qualified medical expenses.

To open an HSA, you need to be enrolled in an HDHP. If you're employed and your employer offers an HSA program as an employee benefit, you can often set up an HSA through your workplace.

If you are self-employed or don’t have an employer-sponsored option available, you can open an HSA with various financial institutions that offer them. Even if you're unemployed, you can still open an HSA if you're eligible and have an HDHP. You'll typically need to complete an application and provide the necessary personal information.

HSA Contributions

If you have an HSA through your employer, you can typically make contributions to your HSA through payroll deductions. Otherwise, you can contribute to your HSA directly, and in both cases, the contributions are tax-deductible and reduce your taxable income. In addition, the interest and earnings on your HSA are tax-free.

However, there are limits on your annual HSA contributions, which vary depending on whether you are 55 years of age or older. Individuals who are 55 or greater can make an additional annual contribution of $1,000.

HSA Contribution Limits:

HSA-Eligible Expenses

When you enroll in an HSA, you’ll receive a debit card or checkbook linked to the account, allowing you to access those funds when you seek medical care. Just swipe the card or write a check from that account, and the money will come directly out of what is in your HSA. If you don’t have enough in your HSA to cover a medical expense, you must pay the remainder using other funds.

Each HSA comes with a list of qualified medical expenses, which typically include copays to doctors and dentists, prescriptions, and medical equipment or supplies. But the list can be even broader in some plans and can include hearing aids, eyeglasses, and therapies such as mental health consulting, physical therapy, and chiropractic services. You can always check with your HSA plan administrator if you are unsure whether an expense qualifies.

HSA Rollover

Don’t need all your HSA funds this year? No problem. You don’t need to spend them on items you don’t need or forfeit your funds entirely. Unused HSA balances are rolled over at the end of the year (unlike the use-it-or-lose-it flexible spending accounts explained in more detail below).

HSA rollover allows your money to continue to grow – potentially earning additional interest – until you need it in the future, even if that’s years away. It’s a wise way to save up for more extensive medical needs you might have as you age or for unforeseen treatments that otherwise would take a bite out of your savings.

HSA Pros And Cons

There are both advantages and disadvantages to HSAs, so they aren’t ideal for everyone.

HSA Plan FAQs

Read on for answers to common questions about HSAs and how to save money with them.

What is the difference between HSA and FSA?

Health savings accounts (HSAs) and flexible spending accounts (FSAs) are both designed to help manage medical expenses, but there are some key differences between HSAs and FSAs.

HSAs are only available to individuals or families with HDHPs, while FSAs can be paired with various health insurance plans, including PPOs and HMOs. HSA contributions can roll over from year to year, allowing you to accumulate savings, whereas FSA funds typically have a "use it or lose it" rule. Also, the participant owns the HSA, and they are portable, so you can move them with you if you change jobs or insurance plans. In contrast, FSAs are usually employer-owned and not portable.

Can I use HSA for dental expenses?

You can use your health savings account to pay for dental expenses. Many dental costs, including routine checkups, cleanings, fillings and orthodontic treatments, qualify as eligible HSA expenses.

However, specific HSA plans may have variations in their lists of qualifying dental expenses. Therefore, it's wise to consult your HSA guidelines to ensure the dental services you plan to pay for are indeed covered.

Can I pay health insurance premiums with HSA?

You typically cannot use an HSA to pay health insurance premiums because the funds are primarily for qualified medical expenses like doctor's visits, prescription medications, and other eligible health care costs. But, there are specific circumstances where you can use HSA funds for premiums, such as when you're receiving unemployment benefits or are using the HSA to continue health coverage through COBRA.

What happens to my HSA if I change jobs?

If you change jobs, your health savings account remains yours, and you can continue to use it for qualified medical expenses. If you remain eligible for an HSA, you can also keep making contributions to the same HSA account with your new employer. HSA funds are portable and not tied to your employer, allowing you to maintain and use them if you change jobs or health insurance plans.

The Bottom Line

An HSA is a fantastic option that allows individuals and families to save for future health care needs with pretax dollars. HSAs are available to people with an HDHP and help reduce their taxable income. In addition, HSAs can grow through annual rollovers and investments, just like other retirement savings plans.

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