A Health Savings Account (HSA) is a type of savings and investment account for medical expenses. The funds in an HSA can be used at any time but only those currently enrolled in a high deductible health plan are eligible to contribute to an HSA.
Tax Advantages of Using an HSA
Health savings accounts have three main tax advantages:
- Contributions to an HSA are tax-deductible. Furthermore, contributions made through payroll are not subject to FICA and FUTA taxes.
- Interest and investment earnings grow tax-free.
- Distributions from the HSA are tax-free when used for qualified medical expenses.
What Medical Expenses are Covered by an HSA?
HSAs can be used to cover qualified medical expenses for you, your spouse, or any tax dependent – even if they are on a different health plan. Qualified medical expenses include most medical and dental procedures, vision care, prescription drugs, lab fees, long-term care insurance premiums, and Medicare premiums.
However, you cannot use HSA funds to pay for supplemental Medigap insurance premiums or over-the-counter drugs.
Note that if distributions are for non-qualified medical expenses, they are subject to income tax, and if the distribution is taken prior to age 65, a 20% excise tax may also apply.
HSA Limits for 2023
If the high-deductible plan is for an individual, the HSA contribution limit for 2023 is $3,850. If it is for a family, the limit is $7,750. Individuals can contribute to HSAs as long as they are enrolled in high-deductible health plans. However, once they enroll in Medicare, they can no longer contribute to an HSA plan.
Health Savings Accounts Best Practices
- Fully fund your HSA: Cash flow permitting, if you are enrolled in a high-deductible health plan, consider contributing the annual maximum amount to your health savings account.
- Invest the HSA: Invest the funds in your health savings account to take advantage of compounding growth over time.
- Cover medical expenses from cash flow: Cash flow permitting, cover your medical expenses from cash flow to allow your health savings account to remain invested until retirement.
- Save your receipts: Save receipts for all medical expenses. You can use these to reimburse yourself from the HSA at a later date.
- Name a beneficiary: It is important to designate a beneficiary on your HSA. When you pass away, what happens to your HSA depends on your beneficiary designation. If your spouse is the beneficiary, they will inherit the HSA and it will be treated as if it is their own. However, is someone other than your spouse is the beneficiary, the account stops being an HSA and the fair market value of the HSA becomes taxable to the beneficiary in the year of your death.
Contributing to an HSA may be a great tool to reduce taxes owed today and to save for future health care costs depending on your situation. If you are interested in a high-deductible health care plan, contact your employer’s HR department and ask if a high-deductible plan is an option. Please also feel free to Contact Us to discuss how an HSA may work in your specific situation.
Editor’s Note: This article was originally published in 2018. It has been updated to reflect 2023s limits.
*Tax references are at the federal level. Individuals should consult with a tax advisor regarding state taxes.