Tax Secrets of Your Health Savings Account

A Health Savings Account (HSA) is a savings account for healthcare expenses with a triple-tax benefit: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical costs. Beyond these core features, specific strategies and lesser-known rules can turn an HSA into a more versatile financial tool for long-term planning.

Foundational HSA Eligibility and Contribution Rules

To open and contribute to an HSA, an individual must be enrolled in a High-Deductible Health Plan (HDHP). An HDHP is defined by specific financial thresholds set by the IRS. For 2025, an HDHP must have a minimum annual deductible of $1,650 for self-only coverage or $3,300 for family coverage. The plan must also have a maximum out-of-pocket limit, which for 2025 cannot exceed $8,300 for self-only coverage or $16,600 for family coverage.

Beyond having qualifying HDHP coverage, eligibility requires that you are not enrolled in Medicare, have no other disqualifying health coverage, and cannot be claimed as a dependent on another person’s tax return.

Once eligibility is established, the amount you can contribute annually is also capped. For 2025, the maximum contribution is $4,300 for individuals with self-only HDHP coverage and $8,550 for those with family coverage. These limits apply to all contributions, including those made by an employer. It is the account holder’s responsibility to ensure the total does not exceed the annual limit to avoid a 6% excise tax on the excess amount.

Individuals who are age 55 or older can contribute an additional $1,000 per year. This “catch-up” contribution is a fixed amount and does not adjust for inflation. If both spouses in a married couple are over 55, each can make a $1,000 catch-up contribution, but they must do so into their own separate HSA accounts, as joint HSAs are not permitted.

Advanced Withdrawal and Reimbursement Strategies

An underutilized HSA strategy involves paying for current medical expenses with post-tax dollars instead of using the HSA. This approach allows the funds within the HSA to remain invested and grow tax-free. Account holders can save all receipts for qualified medical expenses they paid out-of-pocket, as there is no time limit on when you can reimburse yourself from your HSA for these previously incurred costs.

This “shoebox” method turns the HSA into a source of tax-free income in the future. For example, an individual incurs $2,000 in qualified medical expenses and pays for them directly. If those funds grow at an average of 7% annually, after 20 years, the account holder can withdraw the original $2,000 tax-free using the old receipts, while the tax-free growth remains in the account.

You can also use your HSA funds to pay for the qualified medical expenses of your spouse or any tax dependents, even if they are not covered by your HDHP. This allows an individual with a well-funded HSA to act as a healthcare safety net for their family.

The definition of qualified medical expenses is broad. Beyond typical doctor visits, HSA funds can pay for COBRA continuation coverage premiums and qualified long-term care insurance premiums, with the deductible amount based on age. Once an individual is 65 and enrolled in Medicare, they can use their HSA to pay for Medicare Part B, Part D, and Medicare Advantage plan premiums.

The HSA as a Long-Term Investment Vehicle

An HSA can function as a long-term investment account. HSA funds can be invested in a portfolio of assets such as mutual funds, ETFs, and stocks. This allows the account balance to grow at a much faster rate than it would in a cash account, and all of this growth is completely tax-free.

When compared to other retirement accounts, the HSA stands alone. Contributions to a Traditional 401(k) or IRA are tax-deductible and grow tax-deferred, but withdrawals in retirement are taxed as ordinary income. A Roth IRA has tax-free growth and withdrawals but no upfront tax deduction. The HSA is the only account that offers a tax deduction on contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses.

Flexibility increases at age 65. At this point, an account holder can withdraw funds for any reason without the 20% penalty that applies to non-medical withdrawals. If the funds are used for non-medical purposes, they are taxed as ordinary income, making the HSA function similarly to a Traditional IRA.

This dual-purpose nature in retirement provides significant financial adaptability. An individual can use the HSA to pay for healthcare costs tax-free, while also having the option to use it for other living expenses by paying income tax on those withdrawals.

Navigating HSA Tax Reporting and Inheritance

Each year, taxpayers with an HSA must file Form 8889, Health Savings Accounts (HSAs), with their Form 1040. This form is used to report all contributions made by the taxpayer or their employer, calculate the allowable HSA deduction, and report distributions to ensure they were used for qualified medical expenses.

Account holders will receive two key informational forms from their HSA custodian. Form 1099-SA reports the gross distribution amount taken from the account during the year. Form 5498-SA reports the total contributions made to the account for the year. These forms provide the data needed to accurately complete Form 8889.

The tax consequences of HSA inheritance depend entirely on who is named as the beneficiary. If the surviving spouse is the designated beneficiary, they can assume ownership of the HSA, and it remains an HSA in their name. This transfer preserves all the tax advantages, allowing the spouse to continue making tax-free withdrawals for medical expenses.

However, if a non-spouse, such as a child, is named as the beneficiary, the account ceases to be an HSA on the date of the owner’s death. The entire fair market value of the account becomes immediately taxable as ordinary income to the beneficiary in the year of inheritance. This underscores the importance of designating a spouse as the beneficiary when possible.