What Are Tax-Advantaged Medical Savings Accounts?

Tax-advantaged medical savings accounts offer individuals a valuable way to manage healthcare costs and potentially reduce their tax burden. These financial tools encourage saving for current and future medical expenses. They allow individuals to set aside pre-tax money, which can then be used for a wide range of eligible medical services and products. This proactive financial planning helps mitigate the impact of rising healthcare expenditures.

Common Characteristics of Tax-Advantaged Medical Savings Accounts

Most tax-advantaged medical savings accounts share several fundamental features. A primary benefit is the tax advantage, which includes tax-deductible contributions, tax-free growth of funds, and tax-free withdrawals when used for qualified medical expenses. This triple tax advantage helps maximize the purchasing power of saved money. These accounts also help individuals cover out-of-pocket healthcare costs, such as deductibles, co-payments, and prescription medications.

The funds within these accounts cover a broad spectrum of medical, dental, and vision care expenses. Qualified medical expenses are defined by the Internal Revenue Service (IRS). They include costs for the diagnosis, treatment, or prevention of disease, as well as treatments affecting any part or function of the body. While specific rules vary by account type, the overarching goal is to provide a tax-efficient way to pay for necessary healthcare.

Health Savings Accounts (HSA)

Health Savings Accounts (HSAs) are individual-owned accounts established with a qualified trustee to pay or reimburse medical expenses. To contribute to an HSA, an individual must be covered under a High-Deductible Health Plan (HDHP) and generally have no other health coverage. 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’s annual out-of-pocket expenses, including deductibles and co-payments, cannot exceed $8,300 for self-only coverage or $16,600 for family coverage.

Contributions to an HSA can be made by the individual, an employer, or a third party. These contributions are tax-deductible or made pre-tax through payroll deductions, reducing taxable income. For 2025, the maximum contribution limit is $4,300 for self-only coverage and $8,550 for family coverage. Individuals aged 55 and over can make an additional “catch-up” contribution of $1,000 annually.

HSAs offer a triple tax advantage: contributions are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are tax-free. Qualified medical expenses are broadly defined by IRS Publication 502. They include doctor visits, prescriptions, dental care, vision care, over-the-counter medications, and menstrual care products. If funds are withdrawn for non-qualified expenses before age 65, they are subject to income tax and a 20% additional penalty. After age 65, withdrawals for non-qualified expenses are subject to income tax but not the penalty.

HSAs are owned by the individual, not the employer, making them fully portable. This means the account remains with the individual even if they change jobs or health plans. Unused funds roll over from year to year indefinitely, with no “use-it-or-lose-it” rule. HSA funds can also be invested, allowing for potential long-term growth similar to retirement accounts.

Flexible Spending Accounts (FSA)

Flexible Spending Accounts (FSAs) are employer-sponsored plans that allow employees to contribute pre-tax money for eligible healthcare or dependent care expenses. There are three types: Healthcare FSAs, Dependent Care FSAs, and Limited Purpose FSAs. Healthcare FSAs cover medical, dental, and vision expenses. Dependent Care FSAs are for childcare or elder care costs that allow the employee to work. Limited Purpose FSAs are typically offered alongside an HSA and are restricted to dental and vision expenses.

Employees contribute to an FSA through pre-tax payroll deductions, which reduces their taxable income. For 2025, the annual contribution limit for Healthcare FSAs is $3,300. The annual contribution limit for Dependent Care FSAs is $5,000 per household, or $2,500 if married filing separately. The full amount elected for a Healthcare FSA is generally available on the first day of the plan year.

A characteristic of FSAs is the “use-it-or-lose-it” rule, meaning any funds not used by the end of the plan year are typically forfeited. However, employers can offer two exceptions: a grace period or a carryover option. A grace period allows employees an additional 2.5 months to use funds. Alternatively, an employer may permit a carryover of unused funds into the next plan year; for 2025, the maximum carryover amount is $660. Employers can only offer one of these exceptions.

Eligible expenses for Healthcare FSAs are similar to those for HSAs, including deductibles, co-payments, prescription medications, and certain over-the-counter products. Dependent Care FSAs cover expenses such as daycare, after-school programs, and summer day camps for qualifying dependents. FSAs are employer-owned, and the funds are generally not portable, meaning an employee typically loses access to the funds if they leave their job.

Health Reimbursement Arrangements (HRA)

Health Reimbursement Arrangements (HRAs) are employer-funded plans that reimburse employees for qualified medical expenses. Unlike HSAs and FSAs, HRAs are solely funded by the employer, and employees cannot contribute to them. The employer determines the amount of funds available and sets the rules for how the HRA can be used.

HRAs operate on a reimbursement model. Employees pay for qualified medical expenses out-of-pocket and then submit claims to their employer for reimbursement from their HRA funds. The reimbursements received by the employee for qualified medical expenses are generally tax-free. Employers have control over the HRA, including defining eligible expenses, setting maximum reimbursement amounts, and establishing rollover policies for unused funds.

Similar to FSAs, HRAs are employer-owned and are typically not portable if an employee leaves their job. The specific rules and available funds vary depending on the employer’s plan design. Some HRAs may allow funds to roll over from year to year, while others may not. HRAs can be used with various health plans, including traditional group health plans or individual health insurance policies.

Archer Medical Savings Accounts (MSA)

Archer Medical Savings Accounts (MSAs) were a precursor to Health Savings Accounts. They were introduced to help self-employed individuals and employees of small businesses manage healthcare costs. While new Archer MSAs generally cannot be established after 2007, existing accounts continue to function under their original rules.

To qualify for an Archer MSA, individuals needed to be self-employed or an employee of a small employer (fewer than 50 employees) and covered by a high-deductible health plan. Similar to HSAs, the individual could not have other health coverage, be enrolled in Medicare, or be claimed as a dependent. For those with an existing Archer MSA, contributions and earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free.

Existing Archer MSAs allow funds to be used for a range of qualified medical expenses, similar to HSAs. Individuals who were active participants in an Archer MSA before 2008, or became active participants after 2007 due to qualifying employer coverage, can continue to make contributions. These accounts offer a historical example of tax-advantaged healthcare savings.