Health Savings Account (HSA)

What Is a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a tax-advantaged savings account that is created for people who get their insurance coverage through high-deductible health plans (HDHPs). Regular contributions to the account are made by the employee or employer and can be used to pay for qualified medical expenses that are not covered by HDHPs.

The contributions, which have an annual cap, can be used to pay for medical, dental, and vision care as well as prescription drugs.

In addition, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in 2020 in response to the COVID-19 pandemic, allows HSA funds to be used for over-the-counter medications without a prescription and some other health-related products.

Plan holders who are unsure which expenses qualify can check with their employer's HSA administrator or a pharmacist.

Key Takeaways

  • A Health Savings Account is a tax-advantaged account that allows people to save for medical expenses that are not reimbursed by their 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 is owned by an employee but can be funded by the employee or the employer.
  • Contributions are vested and unused balances at year-end can be carried forward.

How an HSA Works

Most people who have high-deductible medical insurance plans have the option of adding an HSA. The two are usually paired together.

  • 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 is $3,600 for an individual and $7,200 for a family as of 2021. Individuals 55 years or older by the end of the tax year can make catch-up contributions of an additional $1,000. In 2022, the HSA contribution limits rise to $3,650 for an individual account and $7,300 for a family account for individuals under the age of 55.

The annual limits on contributions apply to the total dollars contributed by both the employer and the employee.

Qualified people who buy their insurance on their own can open an HSA at certain financial institutions. Contributions by those who receive employer-sponsored health insurance pay for their HSAs through payroll deductions.

Any other person, such as a family member, can also contribute to the HSA of an eligible individual. Self-employed or unemployed individuals may contribute to an HSA if 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.

Special Considerations

HDHPs have higher annual deductibles but lower premiums than other health plans. That is, the monthly costs are lower but the people covered are responsible for their own medical costs up to a set amount.

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 2021 tax year and remains the same in 2022. The plan must also have an annual out-of-pocket maximum, which caps your out-of-pocket medical expenses. The maximums are $7,000 for self-only coverage and $14,000 for families for the 2021 tax year. For 2022, The maximums are $7,050 for self-only coverage and $14,100 for families.

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 co-pay.

For example, 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 $2,000 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 co-pays. An insured can withdraw money accumulated in an HSA to cover these out-of-pocket expenses.

On Sept. 10, 2021, the IRS issued a statement notifying taxpayers that at-home COVID-19 tests and personal protective equipment such as face masks and hand-sanitizer are both considered eligible medical expenses that can be paid or reimbursed under health flexible spending arrangements (health FSAs), health savings accounts (HSAs), and health reimbursement arrangements (HRAs).

Advantages and Disadvantages of an HSA

Health Savings Accounts have a number of advantages as well as drawbacks. The effect of these accounts depends on your personal and financial situation.


Employer contributions and the 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.

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


An obvious drawback is the limits on eligibility. You must have a high-deductible plan and lower insurance premiums, or you're affluent enough to afford the high deductible and still benefit from the tax advantages.

Individuals who fund their own HSAs, through payroll deductions or directly, must be financially able to set aside an amount that would cover a substantial portion of their HDHPs’ deductibles. Individuals with little spare cash to set aside may find this burdensome.  

HSAs also come with filing requirements regarding contributions, specific rules on withdrawals, distribution reporting, and a record-keeping burden that can be burdensome 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 of the basics:

  • Qualified medical expenses include deductibles, dental services, vision care, prescription drugs, co-pays, psychiatric treatments, and some other qualified medical expenses not covered by a health insurance plan. Note: This list was 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 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.

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 keep their HSAs.

An HSA plan can 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, there are some key differences:

  • 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 2021 tax year is $2,750.

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 they are used for qualified medical expenses.

As a person ages, medical expenses tend to increase. 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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