What Is An HSA And Why Should I Participate?

February 09, 2025

An HSA is a type of tax-deferred account designed to help you save for your health care costs for current and future years. An HSA essentially works like an IRA for medical expenses. However, it differs from a Flexible Spending Account (FSA) in that money not spent in a calendar year can remain in the account to be used in future years – or retirement.

HSAs are only available to you if you have coverage through a qualifying high-deductible major medical health plan, referred to as an HDHP. If you can participate in an HSA, you should know these facts:

  • HSAs can be funded with pre-tax income up to certain IRS limits. The money can be withdrawn tax-free for qualified medical expenses, including prescription drugs.
  • You can reimburse yourself right away for qualified medical expenses, or at any time in the future, as long as your HSA was open when the expense was incurred. Just hold on to your receipts, bills, or explanation of benefits.
  • You can also make contributions directly to an HSA via deposit for the prior tax year up until the tax filing deadline (generally April 15th).
  • You may not contribute to an HSA if you are covered by a non-high deductible medical plan including Medicare, TRICARE, a spouse’s family plan, or an FSA or HRA (yours or your spouse’s, unless it is limited purpose).
  • The amount of your HSA contribution directly reduces your taxable income for federal tax purposes, and in most states (CA and NJ are exceptions), so you will pay tax on less income overall.
  • Any money not spent in the year contributed grows tax-free (for federal and most states) in the investment funds you choose, if an investment option is available.
  • If withdrawn for non-qualified medical expenses before age 65, the money will be taxed as ordinary income and will incur a 20% penalty as well. However, once you turn 65, the money may be withdrawn for non-qualified medical expenses without this penalty (only the taxes will be due).
  • HSA accounts may be transferred if you change employers, similar to a rollover from one 401(k) to another.

ACTION ITEMS:

1. Consider participating in an HSA if you want to save money by paying for qualified medical expenses with tax-free dollars or you are looking for other ways to save for retirement on a tax-preferred basis.

2. Be aware that a high-deductible health plan with an HSA may not be the best option for those who have ongoing medical conditions and treatments, or for those who do not have sufficient funds set aside to pay the higher out-of-pocket costs.

3. If you plan to defer much of your HSA balance until retirement, make sure to invest for the long term among the investment options available to you.