When it comes to health insurance, there are a lot of choices and much confusion. In the midst of that, one health-related financial tool stands out as a bright spot: The health savings account (HSA). Those eligible for such an account receive three levels of valuable tax benefits: 1) contributions are tax deductible and as long as the money is used for qualified medical expenses, 2) account growth, and 3) withdrawals are tax-free as well.
Since account balances can be carried forward from year to year (unlike flexible spending accounts, which have an annual “use-it-or-lose-it” provision), HSAs can be helpful in saving not just for today’s health care costs but for later life health care costs as well. For some, an HSA can even be used as a powerful additional retirement savings account with unusually generous tax benefits.
The ABCs of HSAs
Eligibility for a health savings account requires the use of a high-deductible health plan (HDHP). To qualify, an individual’s plan must have an annual deductible of at least $1,750 in 2027; a family’s plan must have an annual deductible of $3,500 or more. (HSAs have no restrictions or phaseouts related to a taxpayer’s income level.)
If your plan meets those requirements, you are eligible to contribute up to $4,500 per year for individuals or $9,000 for families. Those over 55 can add an additional $1,000 per year. This money may be used to pay for deductibles, co-pays, prescription drugs, a wide variety of over-the-counter remedies, eye care, dental care, and even health-insurance premiums if you are unemployed or paying for “COBRA” continuation coverage through a former employer.
HSA funds also may be used to pay a portion of the premiums for most long-term care policies. The allowable annual amount for this purpose depends of your age, increasing as you get older.
Where to open an HSA
Certain banks, credit unions, health-insurance providers, and brokerage firms offer HSAs. SMI Private Client, a separate but affiliated company with SMI, can manage any HSA with a Schwab brokerage window, which includes Lively and HSA Bank.
HSA providers vary widely in the benefits they offer and the fees they charge. Some offer only the ability to save; others allow you to invest money in the account. Some pay very little interest on savings; others pay more. Some charge monthly or annual fees; others charge nothing. Some make it easy to access the money to pay for health care expenses via a debit card; others are designed strictly as long-term savings vehicles.
Several web sites, such as HSAsearch.com, monitor the HSA landscape, listing providers along with fees and account features. Morningstar also issues an annual HSA Report in which it compares the benefits and fees of major providers.
Maximizing HSA contribution benefits
If you have a high-deductible health plan and your employer offers payroll withholding for funding an HSA, that money will not be subject to federal or state income tax (exceptions: California and New Jersey treat HSA contributions as taxable income). Importantly, funding an HSA directly through your employer also means the money won’t be subject to Social Security (6.2% of up to $192,300 in earned income in 2027) or Medicare (1.45% of all earned income) taxes.
If you have an HDHP but can’t fund an HSA through payroll withholding, you can do so yourself. You’ll get both federal and state income-tax benefits by listing the contributed amount on Form 1040 (you do not have to itemize deductions), but you will not receive the Social Security and Medicare tax breaks.
If you’d like to use an HSA custodian other than one tied to your employer, perhaps to avail yourself of better investment options, consider using two accounts — your employer’s and one of your own choosing. You could use payroll withholding to contribute to your workplace HSA (which will enable you to avoid paying all taxes on the money), then move the money into your preferred HSA through periodic “trustee-to-trustee” transfers (be sure to check on any restrictions and fees).
Maximizing HSA withdrawal benefits
If later you switch to a health plan that does not have a qualifying high deductible, or you join Medicare, you are no longer eligible to contribute to an HSA. However, you can still withdraw any already accumulated HSA savings for qualified health care costs. You can even use HSA funds to reimburse yourself for the money Social Security withholds from your benefits to pay Medicare premiums. HSA funds, however, may not be used to pay for supplemental policies such as “Medigap”.
What if you don’t need all the money you accumulate in an HSA for health care expenses in your later years? If you withdraw money before age 65 and use it for anything other than qualified health care costs, you’ll owe taxes and a 20% penalty. But at age 65 or older, you can use the money for whatever you’d like and owe only taxes — no penalty. Just as with a traditional IRA, you received a tax deduction on your contributions, enjoyed tax-deferral on the gains, and now must treat withdrawals as ordinary income for tax purposes.
For high-income earners, there’s one more option worth highlighting — a way to turn an HSA into something of a super IRA, with the benefits of both a traditional and a Roth IRA. Here’s how it works. Prior to age 65, you fund an HSA but pay for health care expenses out of pocket (rather than taking money out of the HSA). Along the way, you keep all the receipts for qualified medical expenses paid with other funds.
In retirement, if you don’t need all the money in your HSA for current health costs, you can begin reimbursing yourself based on the receipts you’ve accumulated for expenses paid with non-HSA funds. This is the best of all worlds: you received a tax deduction on the money you contributed to your HSA originally (like a traditional IRA), and now are able to take out those contributions and earnings completely tax-free (like a Roth IRA).
This strategy works best for high-income earners, because people of more average means typically will need to tap their HSA account to cover current health care costs. But if you can afford to contribute to an HSA and cover health care costs with other funds, it’s a unique, highly tax-advantaged way to create another stream of retirement income.
Is an HSA right for you?
You may have several health insurance options available, especially if you work for a large company. Aiming for the lowest-deductible plan you can afford, perhaps paired with a flexible spending account, may seem attractive. But it’s worth crunching the numbers using your household’s recent health care costs to estimate which option is truly best.
An increasing number of people are finding that a high-deductible health plan paired with a health savings account is the best choice. Because you can carry balances forward and, with some providers, invest the funds, an HSA may turn out to be the most cost-effective way to cover your health care costs now and in the future.
