Should I Have an HSA? How It Works & Who Is Eligible

A Health Savings Account (HSA) provides a specialized savings vehicle designed for healthcare expenses. It offers a way to set aside funds for current and future medical costs. This account operates in conjunction with specific health insurance plans.

Meeting Eligibility Requirements

To qualify for an HSA, an individual must be enrolled in a High-Deductible Health Plan (HDHP). For 2025, an HDHP must have a minimum annual deductible of $1,650 for self-only coverage or $3,300 for family coverage. Additionally, the plan’s annual out-of-pocket expenses, which include deductibles, copayments, and coinsurance but not premiums, cannot exceed $8,300 for self-only coverage or $16,600 for family coverage.

Beyond the HDHP requirement, there are other conditions for HSA eligibility. An individual generally cannot have other health coverage. Enrollment in Medicare also disqualifies an individual from contributing to an HSA. Furthermore, if someone can be claimed as a dependent on another person’s tax return, they are not eligible to establish or contribute to an HSA. Eligibility for HSA contributions is determined monthly, meaning an individual must meet all criteria on the first day of each month to contribute for that month.

Understanding How HSAs Work

An HSA functions as a savings account where funds can be contributed and then withdrawn to pay for qualified medical expenses. Contributions can be made by the individual, an employer, or other third parties. For 2025, the maximum annual contribution is $4,300 for individuals with self-only HDHP coverage and $8,550 for those with family HDHP coverage. Individuals aged 55 and older can make an additional “catch-up” contribution of $1,000 annually.

Funds within an HSA are used to cover “qualified medical expenses.” This includes expenses like deductibles, copayments, prescription medications, vision care, and dental services. Over-the-counter medications and menstrual products are also considered qualified medical expenses. When withdrawals are made for these qualified expenses, they are tax-free. However, if funds are withdrawn for non-qualified expenses, they become taxable income and may incur an additional 20% penalty, especially if the account holder is under age 65.

Unlike some other healthcare accounts, HSA funds roll over from year to year and never expire. This investment potential allows the account to serve as a long-term savings vehicle. The growth of these investments is typically tax-free.

Navigating HSA Tax Implications

HSAs offer distinct tax treatments that can provide financial advantages. Contributions made to an HSA are tax-deductible, meaning they reduce an individual’s taxable income. If contributions are made through payroll deductions by an employer, they are often excluded from gross income and are not subject to federal income tax, Social Security, or Medicare taxes. This upfront tax reduction can lead to immediate savings.

The funds held within an HSA grow on a tax-free basis. Any interest, dividends, or capital gains earned from investments within the account are not subject to federal income tax while they remain in the HSA. This allows the account balance to compound more efficiently over time. This tax-free growth continues as long as the funds are in the account.

Withdrawals from an HSA are also tax-free, provided they are used for qualified medical expenses. This “triple tax advantage” means contributions are tax-deductible, funds grow tax-free, and withdrawals for eligible healthcare costs are tax-free.

However, withdrawals for purposes other than qualified medical expenses are subject to taxation. If funds are withdrawn for non-medical reasons, the amount becomes taxable as ordinary income. Additionally, if the account holder is under age 65, these non-qualified withdrawals incur an extra 20% penalty tax. This penalty is waived once the account holder reaches age 65 or becomes disabled, though the income tax still applies to non-qualified distributions. Individuals who contribute to or take distributions from an HSA during a tax year must report this activity to the IRS by filing Form 8889, Health Savings Accounts (HSAs), with their tax return. Account holders also typically receive Form 1099-SA for distributions and Form 5498-SA for contributions from their HSA administrator.

Steps to Open and Manage an HSA

Opening an HSA typically involves selecting a qualified provider. Many banks, credit unions, and investment firms offer HSA accounts, and some employers facilitate access to specific providers. The process generally requires personal identification information and details about the High-Deductible Health Plan. It is important to confirm that the chosen HDHP meets the IRS requirements for HSA eligibility before proceeding.

Once an account is established, contributions can be made. Many individuals opt for regular payroll deductions, which offer the convenience of pre-tax contributions directly from their paycheck. Direct deposits or one-time transfers from a personal bank account are also common methods for funding an HSA. It is important to track contributions to ensure they do not exceed the annual IRS limits.

Many HSA providers offer investment options, allowing account holders to grow their savings beyond a simple cash balance. Individuals can typically choose from a range of investment funds, similar to a retirement account. The provider’s platform usually guides the selection and management of these investment choices. Regularly reviewing investment performance and allocations is a useful practice.

Effective management of an HSA involves diligent record-keeping. It is important to retain receipts and documentation for all qualified medical expenses, even if immediate reimbursement is not sought. These records are crucial for tax purposes, as the IRS may request verification that withdrawals were for eligible costs. Most HSA providers offer various methods for initiating withdrawals, such as a debit card linked to the account, online transfers, or direct reimbursement for out-of-pocket payments.