Understanding Health Savings Accounts (HSAs): A Comprehensive Breakdown

Understanding Health Savings Accounts (HSAs): A Deep Dive

A Health Savings Account (HSA) is a tax-favorable investment account you can contribute to if you have a high-deductible health insurance coverage. Employers might offer HSAs for their employees, but individuals can also establish their own. Contributions are tax-deductible up to the annual HSA limits, and funds can be withdrawn tax-free to cover qualifying medical expenses.

After reaching 65 years of age, the funds in an HSA can be utilized for any purpose without a penalty, though withdrawals not employed for medical costs will be taxed based on your regular income tax rate.

Did you know? You can utilize your HSA funds, tax-free, to cover qualifying medical expenses.

Understanding Health Savings Accounts

Health Savings Accounts (HSAs) are intended to help individuals with high-deductible health insurance plans cover medical expenses. They lower the out-of-pocket cost of medical care by allowing you to pay utilizing pre-tax money. However, you can also invest your HSA funds for retirement purposes.

HSAs stand out for several significant reasons:

You're eligible to contribute only if you have a qualifying high-deductible health plan.
Your employer can open an HSA for you (and contribute funds on your behalf), or you can open your own and contribute to it.
Funds can be invested and can grow for as long as you'd like; there's no obligation to withdraw funds at any point. With most other tax-advantaged accounts -- including 401(k)s and traditional IRAs -- you're subject to required minimum distributions (RMDs) after age 73 (previously age 72).
HSA funds can be withdrawn tax-free at any age to cover qualifying medical expenses. With 401(K)s) and IRAs), money can't be withdrawn before age 59 1/2 without a 10% penalty unless you qualify for a hardship distribution -- and you're always taxed at your ordinary income tax rate on 401(k) or IRA distributions.
Funds withdrawn for purposes other than covering HSA-eligible expenses are subject to a 20% penalty plus income taxes. This is double the penalty that applies for early 401(k) or IRA withdrawals. However, it applies only until age 65, after which you can withdraw funds from an HSA for any purpose. In this case, you'll just pay ordinary income tax if the money isn't used for healthcare.

How does an HSA work?

Health Savings Accounts can serve as a crucial savings tool. They make it easier to manage medical care costs and can help save for retirement. However, there are rules you need to follow, such as restrictions on eligibility and annual contribution limits.

The rules applicable to Health Savings Accounts are distinct from those that apply to Flexible Spending Accounts (FSAs), although both enable you to pay for medical care with pre-tax funds.

Investing in a HSA

One of the biggest advantages of HSAs is that they can function as more than just a savings account for your healthcare. That's because you are generally allowed to invest the money in the account -- it does not have to remain in cash. This gives you the opportunity to:

Invest pre-tax money in the market.
Increase your wealth through investments without paying taxes on your gains.
Withdraw your money tax-free for medical purposes, including any gains you've made.

No other investment account allows you to put your pre-tax money into the stock market, earn a return on your investment, and never pay taxes on any of the money you make through investing. Because the IRS doesn’t take a cut, an HSA can be a wealth-building powerhouse of an account since all of the returns your investments earn are yours to keep.

Of course, if you use the money for non-medical purposes, you'll be taxed on withdrawals at your ordinary income tax rate. You’ll also owe a 20% penalty if you're younger than 65. Still, you have a chance to invest with pre-tax dollars and defer taxes on gains with this account even if you take this approach, much as you do with a 401(k).

Your investment options depend on where you hold your HSA account, but you’ll often have a selection of index funds similar to what a 401(k) offers. Often these funds allow you to gain broad exposure to the entire stock market or to specific types of companies, such as large, mid-sized, or small companies. You may also have access to bond funds, real estate funds, or emerging market funds.

Investing in funds tends to be simple for even novice investors, and the risks are smaller than when you invest in individual stocks. That makes using your HSA as an investment vehicle an easy way to start putting your money into the stock market, as well as a tax-efficient one.

If you plan to use the money in an HSA within two to five years of contributing it, though, you should generally opt to leave it in cash or a cash equivalent so you aren’t subject to stock market volatility.

However, if you want to leave your money to grow to cover healthcare costs later in life or as an additional retirement account, you should strongly consider investing the money so you can earn returns.

As long as you hold a suitable high-deductible health insurance plan without any additional coverage with deductibles below the specified limits (such as Medicare coverage), you can contribute to an HSA. The stipulations for a high-deductible plan alter yearly, but they must meet two criteria:

The sum of your deductible should meet or surpass a predetermined dollar amount.
Your plan's total out-of-pocket expenses must be beneath a specific ceiling.

The table below provides the minimum annual deductible and maximum annual out-of-pocket costs for an eligible high-deductible health plan in 2024 and 2025. Eligibility is assessed annually, so if your plan complies with the restrictions in 2024 but fails to do so in 2025, you may contribute in 2024 but not in the subsequent year.

| Eligibility Category | Self-Only Health Coverage | Family Health Coverage || --- | --- | --- || Annual Deductible (Minimum) | $1,650 for 2025; $1,600 for 2024 | $3,300 for 2025; $3,200 for 2024 || Annual Out-of-Pocket Costs (Maximum) | $8,300 for 2025; $8,050 for 2024 | $16,600 for 2025; $16,100 for 2024 |

Annual Contribution Limits

Your capacity to contribute to an HSA annually is confined, with the limits depending on whether you have self-only (individual) or family coverage. Contribution limits change yearly, and individuals over 55 are permitted to contribute an additional $1,000 supplementary contribution.

The annual contribution limits for 2024 are:

$4,150 for self-only coverage or $5,150 for self-only coverage if you're 55 or older and eligible for the supplementary contribution.
$8,300 for family coverage or $9,300 for family coverage with supplementary contributions.

$1,650 for 2025; $1,600 for 2024

The annual contribution limits for 2025 are:

$4,300 for self-only coverage or $5,300 for self-only coverage if you're 55 or older and eligible for the supplementary contribution.
$8,550 for family coverage or $9,550 for family coverage with supplementary contributions.

If your employer makes a contribution on your behalf, it is included in these annual limits; hence, if your employer contributes $1,000 and you have self-only coverage in 2025, you can only contribute the remaining $3,300 if you're younger than 55 and have self-only coverage.

Contributions can be made up until the tax deadline for a given year. Thus, you could contribute to your HSA for 2024 until April 15, 2025.

HSAs vs. FSAs

$3,300 for 2025; $3,200 for 2024

HSAs vs. FSAs

Health savings accounts differ from flexible spending accounts, used for paying medical expenses with pre-tax funds. The primary distinctions between an HSA vs. FSA are:

HSA funds can be invested, but FSA money cannot.
FSAs are accessible to everyone with an employer offering them, while HSAs are limited to individuals with high-deductible health plans. FSAs can be used for healthcare, as well as dependent care.

Money contributed to an FSA typically needs to be used in the year the money is contributed, while HSA funds can be saved and withdrawn at any time.

Related: HSA vs. PPO Plans

Did you know? An HSA provides an exclusive triple tax advantage that is absent from other tax-deferred investment vehicles.

How to Open a HSA

How to open and fund an HSA

If you possess a suitable high-deductible health plan, your employer may offer an HSA. If this is the case, it is usually an appealing option, especially if your employer contributes to your HSA.

Alternatively, numerous reputable financial institutions provide HSAs. For example:

$8,300 for 2025; $8,050 for 2024

Lively offers HSAs with an FDIC-insured savings account option alongside the ability to invest your account funds through TD Ameritrade's platform, which allows you to choose virtually any stocks, bonds, ETFs, or mutual funds you wish.
HSA Bank also provides HSAs with the option to invest through TD Ameritrade’s platform or use a guided self-directed investment program that assists you in investing your funds in low-fee mutual funds.

Although multiple HSAs are permissible, the total contribution limits are applicable in aggregate, so you must keep track of the overall investment in all your accounts annually. You will also need to submit a separate Form 8889 for each HSA. Due to its complexity, it often makes sense to maintain a single HSA, either the one your employer opens or the one you open by yourself.

The decision ultimately depends on your goals. If your employer contributes to a particular HSA on your behalf, the choice is generally straightforward. If not, it is wise to compare the features of the plan your employer offers (if any) with a few other options. For instance, if you wish to invest in individual stocks within your HSA, you must find an institution that allows that.

Funds set aside in HSAs allow for medical expenses to be covered using pre-tax income. However, the potential to invest and grow these funds, as well as keeping them in cash, makes HSAs more than just a tool for saving on healthcare expenses. Employing HSAs as a long-term investment option, your HSA balance could help minimize medical expenses during retirement, all while lessening your tax burden in the interim.

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$16,600 for 2025; $16,100 for 2024

After reaching retirement age, you can utilize the funds in your HSA for any purpose without a penalty, although withdrawals not used for medical expenses will be taxed based on your regular income tax rate.

During retirement, your HSA can serve as an additional retirement savings account, as you're allowed to invest the money in the account and withdraw funds tax-free for qualifying medical expenses, including any gains you've made through investing.