Health Savings Account (HSA)

What Is a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a tax-advantaged account created for or by individuals covered under high-deductible health plans (HDHPs) to save for qualified medical expenses. Contributions are made into the account by the individual or their employer and are limited to a maximum amount each year. The contributions are invested over time and can be used to pay for qualified medical expenses, such as medical, dental, and vision care, as well as prescription drugs.

Key Takeaways

  • A Health Savings Account (HSA) is a tax-advantaged account to help people save for medical expenses that are not reimbursed by high-deductible health plans.
  • No tax is levied on contributions to an HSA, on the HSA’s earnings, or on distributions used to pay for qualified medical expenses. 
  • An HSA, owned by an employee, can be funded by the employee and the employer.
  • Contributions are vested and unused account balances at year-end can be carried forward.

How an HSA Works

As mentioned above, people with HDHPs can open HSAs. Individuals with HDHPs may qualify for HSAs and the two are usually paired together. To qualify for an HSA, the taxpayer must meet eligibility standards set out by the Internal Revenue Service (IRS). An eligible individual is someone who:

  • Has a qualified HDHP
  • Has no other health coverage
  • Is not enrolled in Medicare
  • Is not claimed as a dependent on someone else’s tax return

The maximum contribution for an HSA in 2022 is $3,650 for an individual ($3,600 for 2021) and $7,300 for a family ($7,200 in 2021). The annual limits on contributions apply to the total of the amounts contributed by both the employer and the employee. Individuals 55 years or older by the end of the tax year can make catch-up contributions of an additional $1,000 to their HSAs.

An HSA can also be opened at certain financial institutions. Contributions can only be made in cash while employer-sponsored plans can be funded by the employee and their employer. Any other person, such as a family member, can also contribute to the HSA of an eligible individual. Self-employed or unemployed individuals may also contribute to an HSA, provided they meet the eligibility requirements.

Individuals who enroll in Medicare can no longer contribute to an HSA as of the first month of enrollment. But they can receive tax-free distributions for qualified medical expenses, which are discussed below.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act allowed HSA funds to be used for over-the-counter medications without a prescription, as well as certain other health-related products. Plan holders who are unsure about what expenses qualify should check with their HSA administrator or pharmacist.

Special Considerations

HDHPs have higher annual deductibles (the plan pays nothing until you reach these amounts in out-of-pocket expenses) but lower premiums than other health plans. The financial benefit of an HDHP's low-premium and high deductible structure depends on your personal situation.

The minimum deductible required in order to open an HSA is $1,400 for an individual or $2,800 for a family for the 2022 tax year. The plan must also have an annual out-of-pocket maximum of $7,050 for self-coverage and $14,100 for families for the 2022 tax year. These maximums cap your out-of-pocket expenses.

When an individual pays qualified medical expenses equal to a plan's deductible amount, additional qualified expenses are divided between the individual and the plan. For instance, the insurer covers a percentage of the qualified expenses as per the contract (usually 80% to 90%) while the plan holder pays the remaining 10% to 20% or a specified copay.

Using this guide, an individual with an annual deductible of $1,500 and a medical claim of $3,500 pays the first $1,500 to cover the annual deductible. The insured pays 10% to 20% of the remaining $2000 while the insurance company covers the rest.

Once the annual deductible is met in a given plan year, any additional medical expenses are typically covered by the plan with the exception of any uncovered costs under the contract, such as copays. The insured can withdraw money accumulated in an HSA to cover these out-of-pocket expenses.

Health Savings Accounts should not be confused with Health Spending Accounts, which are used by employers in Canada to provide health and dental benefits for their employees in Canada.

Advantages and Disadvantages of an HSA

Health spending accounts have a number of advantages as well as drawbacks. The effect of these accounts depends entirely on your personal and financial situations.


Employer contributions and an individual’s contributions by payroll deduction to an HSA are excluded from the employee’s taxable income. An individual’s direct contributions to an HSA are 100% tax-deductible from the employee’s income. Earnings in the account also are tax-free. However, excess contributions made to an HSA incur a 6% tax and are not tax-deductible.

Distributions from an HSA are tax-free provided the funds are used for qualified medical expenses as outlined by the IRS. Distributions used for medical expenses that are covered under the HDHP plan are included in determining if the HDHP’s deductible has been met.

You can also use the money in your HSA to invest in stocks and other securities, potentially allowing for higher returns over time.


The most obvious key drawback is that you need to be a good candidate for an HDHP. You must have a high-deductible plan and lower insurance premiums or you're affluent enough to afford the high deductibles and can benefit from the tax advantages.

Individuals who fund their own HSAs, whether through payroll deductions or directly, should be financially capable to set aside an amount that would cover a substantial portion of their HDHPs’ deductibles. Individuals without enough spare cash to set aside in an HSA may find the high deductible amount burdensome.  

HSAs also come with filing requirements regarding contributions, specific rules on withdrawals, distribution reporting, and a record-keeping burden that may be difficult to maintain.

Withdrawals Permitted Under an HSA

Amounts withdrawn from an HSA aren't taxed as long as they are used to pay for services that the IRS treats as qualified medical expenses. Here are some basics you need to know:

  • Qualified medical expenses include deductibles, dental services, vision care, prescription drugs, copays, psychiatric treatments, and other qualified medical expenses not covered by a health insurance plan. Note: These were expanded by the CARES Act.
  • Insurance premiums don’t count as a qualified medical expense unless the premiums are for Medicare or other health care coverage (provided you are 65 years of age or older) for health insurance when receiving health care continuation coverage (COBRA), for coverage when receiving unemployment compensation, or for long-term care insurance, subject to annually adjusted limits. Premiums for Medicare supplemental or Medigap policies are not treated as qualified medical expenses.

If distributions are made from an HSA to pay for anything other than a qualified medical expense, that amount is subject to both income tax and an additional 20% tax penalty. However, once an individual turns 65, the 20% tax penalty is eliminated and only income tax would apply for non-qualified withdrawals.

HSA Contribution Rules

Contributions made to an HSA do not have to be used or withdrawn during the tax year. They are vested and any unused contributions can be rolled over to the following year. Also, an HSA is portable, meaning that if employees change jobs, they can still keep their HSAs.

An HSA plan can also be transferred to a surviving spouse tax-free upon the death of the account holder. However, if the designated beneficiary is not the account holder’s spouse, the account no longer is treated as an HSA and the beneficiary is taxed on the account’s fair market value, adjusted for any qualified medical expenses of the decedent paid from the account within a year of the date of death.

HSA vs. Flexible Savings Account

The HSA is often compared with the Flexible Savings Account (FSA). While both accounts can be used for medical expenses, some key differences exist between them:

  • FSAs are employer-sponsored plans
  • only employed individuals can sign up for FSAs
  • unused funds in the FSA during a given tax year can't be rolled over and are forfeited once the year ends
  • your elected contribution amount for an FSA is fixed unlike HSA contributions

The maximum contribution for an FSA for the 2022 tax year is $2,850.

Can I Open an HSA if I'm Self-employed?

Yes. Any individual with an HDHP can open an HSA. If you are self-employed, you can look into HSAs offered by brokerages or banks like Fidelity, HealthEquity, or Lively. Make sure you research your options carefully to ensure you're getting the best HSA to suit your needs.

Do I Have to Use All of the Money in my HSA Every Year?

No. Unlike an FSA, your contributions to your HSA can roll over yearly. Since the funds can also be invested, users can build capital for more significant medical needs or use it as an investment fund after retirement.

Can I Pay My Insurance Premiums With My HSA Funds?

In most cases, no. HSAs can be used for most medical expenses, like doctor's appointments, prescriptions, or over-the-counter medications, but not your monthly premium. The only exception to this rule is when the funds are used to pay Medicare premiums or other healthcare continuation coverage, such as COBRA, while you're on unemployment compensation. You may also pay for long-term care insurance using your HSA.

The Bottom Line

All in all, HSAs are one of the best, tax-advantaged savings and investment tools available under the U.S. tax code. They are often referred to as triple tax-advantaged because contributions are not subject to tax, the money can be invested and grow tax-free, and withdrawals are not taxed as long as you use them for qualified medical expenses.

As a person ages, medical expenses tend to increase, particularly when reaching retirement age and beyond. Starting an HSA at an early age, if you qualify, and allowing it to accumulate over a long period of time, can contribute greatly to securing your financial future.

Article Sources
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