The Power of a Health Savings Account (HSA)
When it comes to managing healthcare costs and maximizing your tax benefits, a Health Savings Account (HSA) can be a powerful tool. Whether you’re planning for future medical expenses or looking for a tax-efficient savings vehicle, understanding how an HSA works can help you make smarter financial decisions.
What is an HSA?
A Health Savings Account (HSA) is a tax-advantaged account designed to help you save for qualified medical expenses—such as copays, dental procedures, emergency room visits, and more. Unlike a Flexible Spending Account (FSA), which requires you to use the funds by the end of the calendar year, an HSA allows you to build and grow your balance over time. This makes it a valuable long-term savings tool for healthcare costs.
It’s important to note that HSAs are only available if you’re enrolled in a High-Deductible Health Plan (HDHP). These plans often come labeled as “HSA-eligible” when you review the health insurance options provided by your employer.
How Does an HSA Work?
If you have an HDHP through your employer, you can set up automatic payroll contributions directly into your HSA. Many employers also contribute to your HSA as part of their benefits package, which is a great added bonus!
Once the funds are in your account, you decide how much to keep in cash versus how much to invest in the various funds your HSA provider offers. Important: How much, and how aggressively you invest your HSA funds depends on a multitude of factors, one of which is how soon you anticipate withdrawing funds from the account.
Accessing your HSA funds is typically straightforward. Most plans provide a debit card linked to your account or allow you to reimburse yourself after paying qualified medical expenses out-of-pocket. A reimbursement occurs when you transfer funds from the HSA to your bank account.
What Are the Tax Benefits of an HSA?
HSAs offer a rare “triple tax advantage” if used properly:
Tax-Deductible Contributions: The money you contribute reduces your taxable income for the year.
Tax-Deferred Growth: Any investment earnings within your HSA accrue without any annual tax payment, similar to retirement accounts and IRAs.
Tax-Free Withdrawals: When you use HSA funds for qualified medical expenses, withdrawals are completely tax-free.
Real-World Example: The Tax Savings Power of an HSA
Meet Sarah:
Age: 35
Filing Status: Single
Annual Income: $75,000
Marginal Federal Tax Rate: 22%
State Income Tax Rate: 5%
HSA Contribution: $4,300
Sarah’s tax savings from her HSA contributions would look like this:
| Tax Type | Calculation | Savings |
|---|---|---|
| Federal Income Tax | $4,300 × 22% | $946 |
| State Income Tax | $4,300 × 5% | $215 |
| Total Tax Savings | $1,161 |
How Much Can You Contribute to an HSA?
For 2025, the IRS sets contribution limits based on the type of health insurance plan and age:
Individual HDHP Coverage: Up to $4,300
Family HDHP Coverage: Up to $8,550
Catch-Up Contribution: If you’re between ages 55 and 64, you can contribute an additional $1,000 each year. If both you and your spouse qualify, you may each make this additional contribution, provided you each have separate HSA accounts.
Important: If you weren’t enrolled in an HDHP for the entire year, your contribution limit is prorated based on the months you were covered by an HDHP. However, the IRS “last-month rule” allows a full contribution if you were enrolled on December 1st and maintain coverage through the following year. I recommend that you consult a tax expert if you are in this situation.
Also, you can make HSA contributions until April 15th of the following year and have them count toward the prior tax year. For example, a contribution made in March 2026 can be designated for the 2025 tax year.
Potential Pitfalls to Avoid
Overcontributing: There is a 6% tax on your excess contributions for each year you fail to remove not only the excess contribution, but the subsequent earnings on the excess contribution. Remember, employer contributions count toward your maximum contribution limit.
Non-Qualified Withdrawals: If you use HSA funds for non-qualified expenses before age 65, you’ll owe income tax plus a 20% penalty. After age 65, non-qualified withdrawals are taxed as income but not penalized.
Summary
An HSA is a powerful savings vehicle if you’re enrolled in a High-Deductible Health Plan.
Funds can roll over year to year—no “use it or lose it” rule like FSAs.
HSAs provide for potential triple tax benefits: deductible contributions, tax-free growth, and tax-free qualified withdrawals.
Contribution limits for 2025 are $4,300 for individuals and $8,550 for families, with catch-up contributions for those 55 and older, but not yet 65.
HSAs are available as part of an employer benefits package or can be opened directly through an HSA provider for the self-employed.
Deciding to enroll in an HDHP and fund an HSA depends on your unique health needs and financial goals. A financial planner can help you evaluate your options and design a strategy tailored to you.
If you’d like to discuss how an HSA can fit into your financial plan, feel free to reach out to me at matthew@payitforwardfp.com. I’m happy to help you navigate these decisions and maximize your savings.