A Health Savings Account lets you set aside money for medical costs before taxes are taken out, then spend it tax-free when you need care

The core advantage is straightforward: money you put into an HSA is not subject to federal income tax or payroll tax. When you withdraw that money to pay for medical expenses, you do not pay tax on the withdrawal either. That is a tax break on both the way in and the way out — something most savings accounts do not offer.

The second advantage is that the money rolls over. Unlike a flexible spending account (FSA), which forces you to spend the balance by the end of the year or lose it, an HSA keeps your balance year to year. If you contribute $3,000 one year and spend only $1,500, the remaining $1,500 stays in the account and grows.

The third advantage is that you can invest the balance. Once your HSA reaches a certain threshold — usually $1,000 to $2,500 depending on the provider — you can invest the money in mutual funds or other securities, the same way you would in a retirement account. The growth on those investments is also tax-free.

Key Takeaways

  • Contributions to an HSA reduce your taxable income, and withdrawals for medical expenses are not taxed, creating a two-layer tax advantage.
  • Unlike FSAs, HSA balances carry forward year to year, so you can build savings over time without losing unspent money.
  • Once your balance reaches a certain level, you can invest the money in stocks or funds, and investment growth is tax-free.
  • You can use HSA funds for a wide range of medical costs: deductibles, copays, prescriptions, dental work, vision care, and some equipment like hearing aids.

How the tax savings work in practice

Suppose you earn $50,000 a year and contribute $2,000 to an HSA. Your taxable income drops to $48,000. If you are in the 22 percent federal tax bracket, that $2,000 contribution saves you $440 in federal income tax. You also avoid the 7.65 percent payroll tax (Social Security and Medicare), which saves another $153. Total: $593 in taxes avoided on a $2,000 contribution.

When you later withdraw $1,200 from the HSA to pay for a root canal, you owe no tax on that withdrawal. If you had paid for the root canal with after-tax money instead, you would have needed to earn roughly $1,540 to have $1,200 left after taxes.

The tax bracket you fall into varies by income and filing status, so the exact savings differ from person to person. The payroll tax savings, however, explore to everyone who contributes.

The difference between an HSA and an FSA

Both accounts let you set aside pre-tax money for medical costs, but they work differently. An FSA is "use it or lose it" — you must spend the balance by December 31 or forfeit it. Some plans allow a $610 carryover (as of 2024, though this amount can change), but anything beyond that disappears.

An HSA has no spending important date. You can accumulate $5,000, $10,000, or more over several years. This matters most if you are young and healthy and do not expect large medical bills. With an FSA, you would have to guess how much you will spend and risk losing money if you guess wrong. With an HSA, you can contribute conservatively and let the balance grow.

An HSA also requires that you be enrolled in a high-deductible health plan (HDHP). An FSA does not — you can have an FSA with any health plan. If your employer offers only a low-deductible plan, you cannot open an HSA through that employer.

How the investment feature compounds over time

If you contribute $3,000 to an HSA each year for 20 years and invest the balance in a fund that returns 7 percent annually, your account would grow to roughly $135,000 — even if you never withdraw a dollar for medical costs. That growth is entirely tax-free.

This is why some people treat an HSA as a retirement account. After age 65, you can withdraw HSA money for any reason without penalty (though non-medical withdrawals are taxed as ordinary income). Before age 65, non-medical withdrawals are taxed and subject to a 20 percent penalty, so most people use HSAs for their intended purpose: paying medical bills.

The investment option is not automatic. You have to move money from the cash portion of your HSA into investments, and not all providers offer the same investment choices. Some HSAs offer only a handful of mutual funds; others offer a wider range. Check what your provider offers before you open the account.

What medical expenses you can actually pay for

HSA funds cover the obvious costs: deductibles, copays, coinsurance, and prescription drugs. They also cover dental work (fillings, root canals, orthodontia), vision care (glasses, contacts, eye exams), and hearing aids. You can use HSA money to pay for physical therapy, mental health counseling, and certain medical equipment like blood pressure monitors or glucose meters.

Over-the-counter medications are covered only if you have a prescription from a doctor. Vitamins and supplements are generally not covered unless prescribed for a specific medical condition. Cosmetic procedures like teeth whitening or Botox are not covered, but the same procedure done for medical reasons (like reconstructive surgery after an accident) would be.

The IRS publishes a full list of may be able to access expenses, and the rules can be technical. If you are unsure whether a specific cost qualifies, ask your HSA provider or check the IRS Publication 502 before you withdraw the money.

The catch: you need a high-deductible health plan

To open and contribute to an HSA, you must be enrolled in a high-deductible health plan. For 2024, that means a deductible of at least $1,600 for individual coverage or $3,200 for family coverage. (These thresholds change yearly.) If your employer offers only a low-deductible plan, you cannot use an HSA through that employer.

Some people view the high deductible as a disadvantage — you pay more out of pocket before insurance kicks in. Others see it as a trade-off: the lower premiums on an HDHP, combined with the tax savings from the HSA, can offset the higher deductible. Whether this trade-off makes sense depends on how much medical care you expect to use and your household income.

You also cannot be covered by another health plan at the same time, and you cannot be claimed as a dependent on someone else's tax return. These restrictions are less common but do affect some people.

How to open an HSA and where the money goes

If your employer offers an HDHP, they usually offer an HSA as well, often through a specific provider like Fidelity, HealthEquity, or Lively. You enroll during your employer's open enrollment period, and contributions are deducted from your paycheck before taxes are calculated.

If you buy your own health insurance, you can open an HSA through a bank, credit union, or investment firm. You contribute money directly, and you deduct the contributions on your tax return (Form 8889). The contribution limits for 2024 are $4,150 for individual coverage and $8,300 for family coverage, though these amounts change annually.

The money sits in an account in your name. If you change jobs or retire, the account stays with you — it does not belong to your employer. You can transfer it to a different HSA provider if you want, and you can continue to contribute to it as long as you remain enrolled in an HDHP.

Frequently Asked Questions

Can I use HSA money to pay my health insurance premium?

No, with one exception: you can use HSA funds to pay for COBRA continuation coverage or premiums for health insurance while you are unemployed. You cannot use HSA money to pay your regular monthly premium while you are employed. You can, however, use it to pay the deductible, copays, and other out-of-pocket costs once you have paid the premium.

What happens to my HSA if I leave my job?

The account is yours, not your employer's. You keep the balance and can continue to use it for medical expenses. You can also continue to contribute to it if you remain enrolled in an HDHP through another source, such as your spouse's plan or an individual plan you purchase yourself. If you switch to a non-HDHP, you stop being able to contribute, but you can still withdraw funds for medical costs.

Can I withdraw HSA money for something other than medical costs?

Yes, but before age 65 you will owe income tax on the withdrawal plus a 20 percent penalty. After age 65, you can withdraw for any reason without penalty, though non-medical withdrawals are taxed as ordinary income. This is why some people use HSAs as a retirement savings tool — the penalty goes away at 65, even if you do not have medical bills.

Do I have to use all my HSA money by the end of the year?

No. Unlike an FSA, an HSA has no spending important date. You can let the balance accumulate indefinitely. This is one of the main advantages — you can build a cushion for future medical costs without worrying about losing unspent money.

Can I invest my entire HSA balance, or do I have to keep some in cash?

Most providers require you to keep a minimum balance in cash — usually $1,000 to $2,500 — before you can invest the rest. This ensures you have money available for when ready medical expenses. Check with your specific provider for their rules.