A Health Savings Account (HSA) is a tax-advantaged savings account designed to help individuals save money for medical expenses. Unlike traditional savings accounts, HSAs offer unique tax benefits that make them an effective tool for saving for healthcare costs both now and in the future. These accounts are often paired with high-deductible health plans (HDHPs), allowing individuals to set aside pre-tax money to cover eligible medical expenses. HSAs provide a range of benefits that can help individuals manage healthcare costs more efficiently, making them a valuable financial planning tool.
How Does an HSA Work?
To open an HSA, you must be enrolled in a high-deductible health plan (HDHP), which typically offers lower monthly premiums but higher deductibles compared to traditional health plans. This structure is specifically designed to work alongside an HSA, allowing you to save for the higher out-of-pocket costs associated with an HDHP. Contributions to an HSA can be made by you, your employer, or both, and these contributions are made on a pre-tax basis, which reduces your taxable income for the year. For 2025, the contribution limits are set at $3,850 for individual coverage and $7,750 for family coverage, with an additional $1,000 catch-up contribution allowed for individuals aged 55 or older. The funds in an HSA can be used for a wide variety of medical expenses, and withdrawals for qualified medical expenses are tax-free. However, if you use the funds for non-medical expenses, the amount will be subject to income tax and a 20% penalty if you’re under age 65. After age 65, you can withdraw the funds for any purpose without the penalty, although income tax will still apply if the funds are not used for qualified medical expenses.
Key Benefits of an HSA
One of the most attractive features of an HSA is its triple tax advantage. Contributions to the account are tax-deductible, meaning they reduce your taxable income, while any earnings from investments within the account grow tax-free. Furthermore, withdrawals used for qualified medical expenses are also tax-free. This makes the HSA one of the most tax-efficient savings vehicles available. Another key benefit is that the funds in an HSA roll over year to year, unlike a flexible spending account (FSA) which often requires you to use the funds within a certain time frame. This allows the balance in your HSA to grow over time without the “use-it-or-lose-it” rule. Additionally, HSAs provide long-term savings potential for healthcare costs in retirement. The money in the account can be invested, allowing it to grow significantly over the years. Once you turn 65, you can use the funds for non-medical expenses without facing a penalty, although you will still pay income tax on those withdrawals. This feature allows an HSA to function similarly to a retirement account. Furthermore, HSAs are portable, meaning the funds remain yours even if you change employers or health plans, giving you flexibility and control over your healthcare savings. The money can be used for a wide range of healthcare expenses, including those not covered by your health insurance plan, such as dental, vision, and mental health services. After age 65, you can also use the funds for non-medical purposes without penalty, making it a valuable supplementary retirement account.
Things to Keep in Mind
To be eligible for an HSA, you must have a high-deductible health plan, which may require you to pay higher out-of-pocket costs before your insurance coverage kicks in. It’s important to assess whether the savings from a lower premium offset the potential costs of a higher deductible. There are also annual contribution limits set by the IRS, and exceeding these limits could result in penalties. For 2025, the contribution limits are $3,850 for individual coverage and $7,750 for family coverage, with a $1,000 catch-up contribution allowed for individuals aged 55 or older. Another consideration is the potential penalty for non-qualified withdrawals. If you use your HSA funds for non-medical expenses, you’ll face both income tax and a 20% penalty if you’re under 65. However, after 65, the penalty is waived, although income tax still applies to non-medical withdrawals. Not all HSAs offer investment options, so if you plan to take advantage of the long-term growth potential, you’ll need to choose a provider that offers investment opportunities such as mutual funds, stocks, or other assets. Be mindful of any associated fees, which can vary by provider.
Who Should Consider an HSA?
An HSA can be a great option for individuals who have a high-deductible health plan and want to save for both current and future healthcare expenses. It’s also ideal for those looking to build long-term savings with tax-free growth and withdrawals for medical expenses. Additionally, an HSA is a strong option for individuals who can afford to pay out-of-pocket healthcare costs while saving money in the account. Since the funds roll over year to year, an HSA is particularly beneficial for individuals who are financially able to cover their current medical expenses and allow the account to grow over time. The more you contribute, the more you can benefit from the tax advantages while building a cushion for future healthcare costs.
Conclusion
A Health Savings Account (HSA) is a powerful tool for managing healthcare expenses, offering substantial tax advantages and long-term savings potential. By contributing to an HSA, you can reduce your taxable income, save for future medical costs, and even grow your funds over time through investments. Whether you’re aiming to cover medical expenses in the short term or preparing for healthcare costs in retirement, an HSA provides flexibility, tax benefits, and the potential for significant growth. For eligible individuals, an HSA can be a key component of a comprehensive financial plan.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Katherine Sullivan, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security, or any security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary.
