This article was originally posted in August 2023 and has been updated in December 2023, to reflect new changes.

What is a Health Savings Account (HSA)?

Health Savings Accounts provide individuals and families with a tax-advantaged way to save for qualified medical expenses not covered by their health care plan. The account is owned by an individual and funded by the individual and/or their employer. Contributions to the HSA are tax-deductible, can be invested over time, and distributions are tax-free if used to pay for qualified medical expenses – medical, dental, vision care, and prescription drugs.

Who can set up an HSA?

HSAs were created for individuals covered under high-deductible health plans (HDHPs). As the name suggests, these plans have a high-deductible but charge a lower monthly premium. With the higher deductible, individuals will have to cover more health care expenses out-of-pocket before the insurance coverage kicks in. HSAs are often paired with HDHPs to help employees save and pay for these out-of-pocket expenses. The Internal Revenue Service (IRS) sets the eligibility standards for an individual who:

• Is covered under an HDHP.
• Has no other health coverage.
• Is not enrolled in Medicare.
• Is not claimed as a dependent on someone else’s previous year’s tax return.

If an individual meets these criteria, they may set up and contribute to an HSA.

Contribution limits

Much like retirement accounts, HSAs are subject to maximum contribution limits and eligibility requirements (discussed above). The maximum contribution allowed for an HSA in 2024 is $4,150 for an individual or $8,300 for a family. Once the account owner reaches age 55, an additional $1,000 can be contributed annually ($5,150 for individuals or $9,300 for a family). This is the amount allowed to be contributed by both the employer and the employee to the HSA account.

Once an individual enrolls in Medicare, their contribution limit is $0. This begins with the first month in which the individual enrolls. For example, if an individual account owner turns 65 and signs up for Medicare in August, their contributions would be limited to the seven months of the year that they were not covered by Medicare (January – July), plus the $1,000 catch-up. Limit in this example: (7months/12months) x ($4,150 annual limit + $1,000 catch up) = $3,004.17. If an individual is still employed and not on Medicare past age 65, they are still eligible to contribute.

Benefits of an HSA

Tax Benefits

The tax benefits of HSAs are unmatched compared to other financial vehicles. HSAs are triple-tax-free, meaning an individual doesn’t pay tax on the money when they contribute, the gains grow tax-deferred, and withdrawals are tax-free if used for qualified medical expenses. These tax advantages are why many financial professionals recommend maxing out your HSA contribution before maxing out your 401k.

Flexibility

Tax savings are wonderful, but what truly sets HSAs apart from other health savings options is flexibility. In an HSA, you:

• Control how much you contribute (up to the annual limit) and when you take funds out.
  • You decide how much and when you want to contribute. Contributions are immediately vested, and unused funds roll over to the next year.
  • Funds can be withdrawn to help pay medical expenses or left in the account to grow. HSAs also are not subject to required minimum distributions.
  • HSAs are also portable, meaning individuals can keep their HSA even if they change jobs or retire.
• Have a wide range of qualified expenses.
  • Qualified medical expenses include deductibles, dental services, vision care, prescription drugs, co-pays, psychiatric treatments, and other qualified medical expenses not covered by a health insurance plan.
  • Certain insurance premiums can be paid using HSA funds.
    • Long-term care insurance (subject to limits based on age that adjust annually)
    • Health care continuation coverage, such as COBRA
    • Health care coverage while receiving unemployment compensation
    • Medicare & other health care coverages if you were 65 or older

Strategies to make the most of your HSA

Hold onto those receipts!

Any qualified medical expense (as listed above), regardless of the year, can be used to justify a tax-free withdrawal. Meaning: you may have a medical expense this year, but you aren’t required to use your HSA money to pay for that expense this year. You can pay for that expense out of pocket now, keep the funds in your HSA, and allow them to keep growing. As long as you have the receipt for that expense, you can take a withdrawal from your HSA and reimburse themselves for that amount at a future date.

Let’s look at an example to see how this works:

An individual has a medical expense in 2024 of $1,000. They have other funds set aside to pay for this expense, so they can keep their funds growing in the HSA. In 2034, that individual decides to retire and would like $1,000 to help cover some travel expenses. He is free to take $1,000 out of his HSA and use the receipt from the 2024 expense to get the tax-free withdrawal.

Invest for the short & long term

Historically, medical costs have risen faster than general inflation and medical needs tend to increase as individuals age. If you plan to use your HSA funds for future use, it likely makes sense to invest funds within the account. Having a strategy and set asset allocation that considers your time horizon, risk tolerance, and amount of other funds available to pay for medical bills is recommended.

While you may not plan to use your HSA now, medical expenses aren’t always predictable. Because of this, having a set amount of cash or cash-like investments within the account is generally a good idea.