What Is an HSA?

By Patrick Means

Are you looking to learn the ins and outs of health savings accounts, from the basics (what is an HSA, anyway?) to the tax benefits? I've got all the details below, but first, I'll share my personal experience and how it worked for me.

A health savings account (HSA) can be a very good deal, especially for someone in their 20s and 30s who's just starting out. If you're enrolled in a high-deductible health care plan (HDHP)* that offers an HSA, consider using it to sock away extra money for future medical needs. The combination of tax advantages and a long time horizon is ideal for making the most of this particular benefit, not only to handle potential healthcare expenses but also to help build long-term financial security.

I know this from experience. When I first entered the workforce, I had the typical health insurance plan with copays. That worked okay for a while. But in my late 20s, I learned about HSAs and decided to reevaluate. And the more I found out, the more an HSA made sense to me.

Here was my thinking: The high-deductible health plan offered with the HSA had lower premiums than the copay option. I figured I could save on the insurance premiums and put the difference toward the HSA up to the maximum amount.

Plus, there were tax deductions, the potential to earn interest, even invest the savings—and take the money out tax-free for qualified medical expenses. As a young, single guy who rarely went to the doctor, it checked all my boxes. And I knew by starting young, I'd really be taking advantage of the long-term benefits to build towards my future.

Then a couple years later, I ruptured my Achilles tendon and had to have surgery. And you know what? My insurance coverage was great. Most of the expenses were covered, and what I needed for a deductible and coinsurance I could take out of the HSA. I didn't have to dip into my savings. It was a total win.

It worked for me. But you have to decide for yourself. So, let's explore how HSAs work, who can enroll, specific tax benefits, contribution limits, and more to help you make an informed decision.

What is an HSA?

An HSA is a tax-advantaged account available to those who have a qualifying high-deductible health plan. In 2024, that's a plan with deductibles of at least $1,600 for an individual or $3,200 for a family. One benefit of an HDHP is that monthly premiums are comparatively low.

For a person with few medical expenses, that can be a pretty good deal right there (provided you can cover the higher deductible). But there's more. Similar to an IRA, an HSA lets you make annual contributions and can offer significant tax perks, but make sure to speak with your tax advisor to see what is right for your situation.

Who can enroll in an HSA?

You're eligible for HSA enrollment if all of these are true:

• You have a qualifying high-deductible health plan
• You're not covered by any plan that's not an HDHP (such as your spouse's)
• You're not enrolled in Medicare
• You can't be claimed as a dependent on someone else's tax return

Unlike deductible IRAs or Roth IRAs, there are no income limits associated with contributions to an HSA. This means that higher wage earners can take advantage of a federally tax-deductible account. This is an approach that high income earners could use to reduce their taxable income. In this way, contributions to an HSA can help reduce taxable income.

HSA tax benefits

One of the biggest advantages of an HSA is that it offers a triple tax advantage, which means:

• Contributions to an HSA are federally tax-deductible, reducing your taxable income. Depending on where you live, you may also get a break on state income taxes.
• Assets in an HSA can potentially grow federal tax-free.
• Withdrawals for qualified out-of-pocket expenses** are also tax free. Qualified expenses can include deductibles, copayments, prescription drugs, and necessary medical equipment, as well as medical care not covered by insurance such as dental, vision, hearing, and long-term care. HSA-eligible expenses are not limited yourself only—you can also use it to pay for medical expenses for a spouse or other dependent.

HSA drawback:

• If you take the money for something other than a qualified medical expense, it's a different story. In that case, you'd pay ordinary income taxes on the withdrawal and a tax penalty if you're under age 65. (Starting at age 65, HSA withdrawals for non-medical expenses are penalty-free but subject to ordinary income tax.)

HSA contribution limits

Of course, all these benefits only work if you actually fund your HSA, and that means making contributions, ideally up to the max allowed. For 2024, annual contribution limits are $4,150 for an individual, $8,300 for a family. (These go up to $4,300 and $8,550 in 2025.) Plus, there's an extra $1,000 annual catch-up contribution for those 55 and over.

If your employer offers an HSA as a benefit, you may be able to set up automatic payroll deductions. Some employers may also offer contributions. Just be aware that total contributions can't exceed the annual limit. Check with your benefits provider and tax advisor.

If you're on your own in making contributions, you may be able to set up an automatic monthly deduction from your bank account or simply write a check to the HSA account. But however you make the payments—consider making them consistently. You don't have to contribute the max, but if you can, it's a great way to increase your savings.

Here's an example that may convince you. Let's say you contribute $4,150 per year for 35 years. That may sound like a lot, but it's actually about $346 per month. Let's also say that you withdraw an average of $1,000 worth of distributions per year to cover health care costs. If you earned an annual average of five percent on the balance of your HSA, you'd end up with about $292,000. But remember that all investing involves risk, and this includes the potential loss of principal.

Crunch the numbers for yourself

Use this Health Savings Account calculator to help see how much your Health Savings Account (HSA) could be worth over time. Fine-tune your account strategy by using the calculator to see what could happen if you change the amount you're contributing to your HSA.

You can never lose your HSA funds

A particularly positive feature of an HSA is that if you don't use it, you don't lose it (unlike a flexible spending account, or FSA). So there's no pressure to spend for the sake of spending. If you don't need to use it, just let that money potentially grow tax-free. Plus, an HSA is portable. If you change employers, you can take it with you.

You can invest your HSA funds

An HSA isn't just a savings account; it can also be an investment account. So if you're fortunate enough not to need the money to cover ongoing medical costs, you may be able to invest your HSA balance in mutual funds, ETFs, stocks, or fixed income (your investment options will depend on what the plan offers, your risk tolerance and time horizon, and typically once a minimum account balance is reached).

Time is, of course, a key factor in taking full advantage of the investment growth potential of an HSA. And especially in your 20s and 30s, time is one of your greatest assets. Put it to work now and your HSA could be a supplement to your retirement accounts, or maybe even act as a retirement account for healthcare when you reach those golden—yet often costly—years.

Is an HSA worth it?

Generally, if you're younger and/or healthier, an HSA could definitely be worth it. What's in it for you is major healthcare coverage, potentially lower insurance premiums, and a tax-deferred account that can grow over time. Plus, you're being tax smart by using the right tax-advantaged account for the right expenses, so ideally you won't have to dip into your emergency fund or investment accounts to cover medical costs—even if your family expands or your healthcare needs change. A drawback to consider is that HSA funds must be used for qualified medical expenses. As mentioned earlier, if you withdraw the funds for something else, you'd pay ordinary income taxes on the withdrawal and a tax penalty if you're under age 65. And, starting at age 65, HSA withdrawals for non-medical expenses are penalty-free but subject to ordinary income tax.

Opening an HSA with a HDHP made sense for me in my 20s, and it still makes sense for me today. If an HSA fits your situation, I'd say explore it more if it's available to you.

*See IRS publication 969 for other qualifications for an HDHP https://www.irs.gov/publications/p969

**See IRS publication 969 for what qualifies for tax-free distributions https://www.irs.gov/publications/p969

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

This tax information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends that you consult with a qualified tax advisor, CPA, financial planner, or investment manager. Depending on the type of account you have, there are different rules for withdrawals, penalties, and distributions. Please understand these before opening your account.

Please consult with your legal counsel and tax advisor about your particular circumstances. Third party HSA providers are not owned by, affiliated with, or supervised by the Schwab or its affiliates nor is Schwab or its affiliates responsible for the services provided by these HSA providers.

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