How to Maximize Your Health Savings Account (HSA)

A Health Savings Account (HSA) is a financial tool designed to help individuals manage healthcare expenses. This account serves as a savings and investment vehicle, specifically paired with a high-deductible health plan (HDHP). It provides a triple tax advantage: contributions are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are also tax-free.

Optimizing Your Contributions

Maximizing annual contributions to your Health Savings Account is fundamental to leveraging its benefits. The Internal Revenue Service (IRS) establishes annual contribution limits, which vary based on your health plan coverage. For 2025, individuals with self-only HDHP coverage can contribute up to $4,300, while those with family HDHP coverage can contribute up to $8,550. These limits represent the combined total from all sources, including personal and employer contributions.

Individuals aged 55 and older are eligible for an additional “catch-up contribution” of $1,000 annually. This allows those nearing retirement to further boost their savings, provided they are not enrolled in Medicare. If both spouses are 55 or older, each can make a catch-up contribution to their respective HSAs. Consistently contributing the maximum allowable amount each year enhances the compound growth potential and amplifies tax advantages over time.

Contributions can be made through direct payments to the HSA provider or convenient payroll deductions. Payroll deductions offer an additional tax benefit, as they are typically made pre-tax and are not subject to Social Security or Medicare taxes. For individuals who become HSA-eligible mid-year, contributions are prorated based on the number of months of eligibility.

A special provision, known as the “last-month rule,” allows individuals who become HSA-eligible by December 1st of a given year to contribute the full annual amount for that year. However, this rule comes with a “testing period” requirement, meaning the individual must remain HSA-eligible through December 31st of the following year. Failure to meet this testing period can result in excess contributions being treated as taxable income, subject to a 10% penalty.

Leveraging Investment Growth

A significant advantage of a Health Savings Account is its capacity for investment growth, which differentiates it from standard savings accounts. HSAs allow funds to be invested in assets such as mutual funds, exchange-traded funds (ETFs), and individual stocks. This investment capability helps funds keep pace with inflation, covering future healthcare costs.

Choosing an HSA provider that offers a robust selection of investment options and maintains low fees is important for maximizing growth. Some providers may require a minimum balance to be held in cash before allowing investments, which can limit the growth potential of smaller balances. Certain providers, like Fidelity, offer broad investment choices without a minimum balance and often feature low or no account maintenance fees.

Growth within an HSA is tax-free; any interest, dividends, or capital gains earned on investments are not subject to federal income tax as long as the funds remain in the account. While federal taxes on investment gains are avoided, some states may still levy taxes on these earnings. Unlike some other retirement accounts, HSAs are not subject to Required Minimum Distributions (RMDs), allowing the funds to continue growing tax-free for an extended period.

Strategic Use of HSA Funds

Strategic utilization of Health Savings Account funds is important for realizing their full long-term benefits, especially as individuals approach and enter retirement. When used for qualified medical expenses, withdrawals from an HSA are completely tax-free, completing the “triple tax advantage” that includes tax-deductible contributions and tax-free growth. This tax-free withdrawal feature applies to a wide range of expenses defined by the IRS in publications such as IRS Publication 502.

A common strategy involves paying for current medical expenses out-of-pocket and saving receipts. This approach allows the HSA funds to remain invested and continue growing tax-free for a longer duration. There is no time limit for reimbursing yourself for past qualified medical expenses, provided you retain proper documentation. Qualified medical expenses encompass a broad array of healthcare costs, including deductibles, copayments, prescription medications, and dental and vision care.

HSA funds can also be used to pay for certain insurance premiums, such as Medicare Parts A, B, and D, as well as Medicare Advantage plans. Additionally, long-term care insurance premiums are considered qualified medical expenses, though there are specific age-based limits on the amount that can be deducted tax-free. Medigap (Medicare Supplement) plan premiums are generally not considered qualified expenses for HSA withdrawals.

Once an individual reaches age 65, HSA withdrawal rules become more flexible. At this age, funds can be withdrawn for non-medical expenses without incurring the 20% penalty that applies to non-qualified withdrawals before age 65. These non-qualified withdrawals will be taxed as ordinary income, similar to withdrawals from a traditional IRA or 401(k).

Upon the death of an HSA account holder, fund disposition depends on the designated beneficiary. If a spouse is named as the beneficiary, they can inherit the HSA tax-free and continue to use it as their own. If a non-spouse is the beneficiary, the HSA ceases to be an HSA, and funds are distributed and taxed as income to the beneficiary in the year of death. The non-spouse beneficiary can use inherited funds to pay for the deceased’s outstanding medical bills incurred within 12 months of death, and these specific withdrawals are tax-free. If no beneficiary is named, HSA funds become part of the deceased’s estate and are included as taxable income on the final tax return.