Quick overview

Health Savings Accounts (HSAs) are accounts paired with a qualified high-deductible health plan (HDHP) that help you save pre-tax money for medical costs. They offer three tax advantages: contributions reduce taxable income, investment earnings grow tax-free, and withdrawals for eligible medical expenses are tax-free (IRS: Publication 969) — making HSAs one of the most tax-efficient savings vehicles available for health and retirement planning.

This article explains who can use an HSA, how contributions and withdrawals work, recordkeeping and reporting, practical strategies I use with clients, and common pitfalls to avoid. This is educational content and not individualized financial or tax advice; consult a certified tax advisor or CFP for your situation.

(Author note: In my practice I frequently recommend HSAs as both a near-term safety net and a long-term investment vehicle when clients qualify for an HDHP.)

Who is eligible for an HSA?

To open and contribute to an HSA you must meet these general rules:

  • Be covered by a qualified HDHP on the first day of the month. See the current HDHP definitions on the IRS site and HealthCare.gov for yearly thresholds.
  • Not be covered by other disqualifying health coverage (for example, a non-HDHP spouse plan that covers you or certain limited-purpose FSAs during the year may disqualify you from HSA contributions).
  • Not be enrolled in Medicare Part A or Part B.
  • Not be claimed as a dependent on another person’s tax return.

For details and the official definitions, see IRS Publication 969 and HealthCare.gov’s HSA glossary (see sources at the end).

How contributions work

  • Contribution sources: Contributions can come from you (after-tax, then deducted on your tax return), from your employer (pre-tax through payroll), or both.
  • Annual limits: The IRS sets annual HSA contribution limits (including employer and employee contributions). Always check the IRS HSA limits page for the current year before planning contributions (IRS: HSA limits and Pub 969).
  • Catch-up contributions: If you are age 55 or older and not yet enrolled in Medicare, you generally can make an additional “catch-up” contribution. Confirm the current catch-up amount on the IRS site.
  • Contribution timing: Contributions for a tax year can usually be made through the tax-filing deadline for that year (typically April of the following year). Keep records of deposit dates and whether contributions were designated for a specific tax year.
  • Employer vs. employee: Contributions made through payroll reduce your taxable wages immediately. If you contribute directly to the HSA, you can claim the deduction on your Form 1040 (see IRS Form 8889 instructions).

Practical tip from my practice: Automate payroll contributions up to the maximum you can afford. That reduces taxable income and avoids the temptation to spend HSA dollars on non-medical items.

What counts as a qualified medical expense?

Qualified medical expenses are defined in Section 213(d) of the Internal Revenue Code and include costs such as copays, prescriptions, dental work, vision care, and many over-the-counter items when allowed by law. Qualified expenses change occasionally, and the IRS publishes guidance and examples in Publication 502 and Pub 969. Keep receipts and notes describing the expense and date — you may need them if the IRS asks.

Withdrawals and tax treatment

  • Tax-free withdrawals: Money you take out to pay for qualified medical expenses is tax-free when you use the funds for eligible costs incurred after the HSA was established.
  • Non-qualified withdrawals: If you withdraw funds for non-medical uses before age 65, you’ll owe income tax on the distribution plus a 20% penalty (this penalty is subject to change — confirm current rules with the IRS). After age 65, non-qualified withdrawals are taxed as ordinary income but generally not subject to the 20% penalty (a treatment similar to traditional retirement accounts).
  • Reimbursement strategy: You can pay out-of-pocket for medical expenses and let receipts accumulate, then reimburse yourself later tax-free — there’s no statutory time limit on when you must take the distribution, provided the expense was incurred after the HSA was opened and you can substantiate it with records.

Example from practice: A client saved receipts for several years while letting her HSA investments grow. She later withdrew funds tax-free to cover a major surgery she’d paid out of pocket two years earlier.

Investments, growth, and fees

Many HSA custodians offer investment options (mutual funds, ETFs) once your balance exceeds a minimum threshold. Investment gains are tax-free when withdrawn for qualified expenses. But watch fees — some custodians charge account maintenance fees or high fund expense ratios that can erode long-term growth.

Professional tip: Compare custodial fees and investment menus before opening an HSA. If your goal is long-term growth, choose a low-cost custodian with a broad ETF or mutual-fund lineup. If you need short-term liquidity, prioritize low or no monthly fees and easy debit access.

Recordkeeping and IRS reporting

  • Keep receipts and documentation for every qualified medical expense you reimburse from the HSA.
  • File Form 8889 with your federal tax return to report contributions, distributions, and to reconcile employer contributions. The HSA custodian will also send Form 5498-SA reporting contributions for the year.
  • The IRS may request proof of expenses if it audits Form 8889; good recordkeeping reduces audit risk and protects your tax-free distributions.

Coordination with other benefit accounts

  • HSA vs. FSA: Flexible Spending Accounts (FSAs) often have different rules; many FSAs are not compatible with HSA eligibility. If you have an FSA, check whether it’s a limited-purpose FSA (which may permit HSA contributions) and review rollover rules (see our HSA vs. FSA guide for side-by-side rules and decision points: HSA vs. FSA).
  • Employer-sponsored plans: If your employer offers an HSA contribution, treat it as part of your total annual contribution limit. Employer contributions count toward your limit even if you don’t deposit the funds yourself.

Portability and what happens if you change jobs or enroll in Medicare

HSAs are individually owned and portable. If you change jobs, your HSA goes with you — you can leave it, roll it to another custodian, or continue using it. Once you enroll in Medicare, you generally can’t contribute to an HSA, though you can use existing funds for qualified expenses (including some Medicare premiums under limited conditions) — consult IRS guidance on Medicare coordination.

Common mistakes and how to avoid them

  • Missing receipts: Always keep documentation. A good folder or digital scan system saves headaches.
  • Exceeding contribution limits: Monitor combined employer and employee contributions to avoid excess contribution penalties; excess amounts typically must be withdrawn and reported.
  • Using funds for non-qualified expenses without understanding tax consequences: Understand the potential 20% penalty (if under 65) and ordinary income tax for non-qualified withdrawals.

Frequently asked practical questions

  • Can I invest HSA funds? Yes — many custodians offer investment options. If you plan to use HSA as a retirement-health tool, treat it like a long-term account and minimize fees. See our article on HSA investment choices and growth strategies: Maximizing HSA Growth: Long-Term Investment Strategies.

  • Are HSA distributions taxable in retirement? Qualified medical withdrawals are tax-free at any age. Non-medical withdrawals after age 65 are taxed as ordinary income but not penalized.

  • How long can I wait to reimburse myself? The IRS doesn’t set a specific deadline for reimbursements; you can reimburse yourself years later for eligible expenses incurred after the account opened, provided you keep documentation.

Bottom line and next steps

HSAs are a flexible, tax-efficient way to pay for medical costs and to save for future healthcare needs, including in retirement. If you qualify because you carry a compatible HDHP, consider:

  • Confirming current IRS limits before planning contributions (IRS Publication 969 and the HSA limits page).
  • Comparing custodial fees and investment choices.
  • Tracking receipts and filing Form 8889 with your tax return.

This article is educational and not personalized tax or financial advice. For tailored guidance, consult a tax professional or certified financial planner.

Authoritative sources

Internal resources

Professional disclaimer: This content is for educational purposes and should not be taken as individualized tax or investment advice. Consult a qualified advisor for personal recommendations.