How a health savings account (HSA) works

Health coverage plan combines tax-advantaged personal savings with high-deductible health insurance policy (HDHP)

If you’re considering a health savings account, but you’re on the fence about whether it’s the right move for you, here are 10 HSA advantages to keep in mind.

Infographic: The HSA: ‘Swiss-Army knife’ of tax-advantaged accounts?

Would you like the ability to pay for medical expenses with pre-tax money? What about the option to build retirement savings that can be used at any time — without taxes or penalties — to pay medical expenses that arise along the way? Do you prefer coverage that comes with a higher deductible and lower premiums?

A health savings account (HSA) could be just what the doctor ordered. Used wisely, this innovative approach to health coverage may provide major advantages that could keep both your personal and financial life healthy.

A health savings account is a tax-advantaged personal savings account that works in combination with an HSA-qualified high-deductible health insurance policy (HDHP) to provide both an investment and health coverage. The savings account provides the funds you use to pay medical expenses or — if you don’t need to use it — is an interest-bearing nest egg that grows until you retire. The HDHP, meanwhile, is your safety net should you need catastrophic coverage for major medical expenses.

How an HSA works

Opening an HSA allows you to pay lower federal income taxes by making tax-free deposits into your account each year. Most states (all but California, Alabama, and New Jersey) also offer tax breaks on funds deposited in these accounts. The 2018 contribution limit is $3,450 if you have individual coverage under your HDHP, and $6,900 if you have family HDHP coverage. You can deduct your contributions even if you take the standard deduction and don’t itemize. If you’re 55 or older, you can contribute an extra $1,000 a year.

[Note that the family contribution limit was initially set at $6,900 for 2018. A March 2018 IRS bulletin reduced it to $6,850, as a result of changes to the inflation adjustment procedure that were implemented by the Tax Cuts and Jobs Act, but the IRS opted in April 2018 to set the contribution limit back to $6,900, due to the administrative challenges associated with a mid-year change in the contribution limit.]

The money you deposit into your HSA is yours to withdraw at any time to pay for medical expenses that aren’t paid by your high-deductible individual health insurance policy. HSAs are considered part of consumer-driven health care (CDHC), meaning that you control the plan, deciding how to spend and invest those dollars.

Expenses may include deductibles, copayments, coinsurance, vision and dental care, and other out-of-pocket medical costs. And the range of services that qualify is broad: You can use your HSA to pay for acupuncture, chiropractor services, or even traditional Chinese medicine (everything you can use it for is listed in IRS Publication 502). Since 2011, however, individuals have not been able to use tax-advantaged money from an HSA for over-the-counter drugs that are not prescribed by a doctor.

You can also use the account to pay for the medical expenses of a spouse or other family members (dependent children or qualifying relatives), even if they aren’t covered by your HDHP.

If you’re fortunate enough to not need to withdraw from the account to pay for medical expenses, your funds roll over from year to year and your account continues to grow (including investment returns or interest, depending on where you deposit your HSA funds).

When you reach age 65, you’re allowed to draw from any unspent HSA funds. You can still spend the funds tax-free for medical expenses, or you can withdraw them without penalty to use them for non-medical expenses (though you will pay income tax on the withdrawals if you don’t use them for medical purposes, just as you would if the funds were in a traditional IRA). If you withdraw the funds prior to age 65 for purposes other than paying medical expenses, you’ll owe a 20 percent penalty on the withdrawal, in addition to income taxes.

Sounds too good to be true? Well, remember that you’re paying a lower premium for your insurance coverage because it’s a high-deductible plan that doesn’t cover anything other than preventive care before the deductible. If you need to see the doctor, you’ll pay the entire bill (reduced according to the negotiated rates your health plan has with the doctor) if you haven’t yet met your deductible.

2018: Higher contribution limits, deductibles, and out-of-pocket maximums

HSA-qualified plans have deductibles starting at $1,350 for singles and $2,700 for families in 2018.

But HSA-qualified plans have also always had limits on how high the maximum out-of-pocket can be — unlike the rest of the market, which didn’t have limitations like that until 2014 when the bulk of the ACA was implemented. In 2018, as has been the case since 2015, the maximum out-of-pocket limits for HSA qualified plans is lower than the maximum out-of-pocket established for all plans under the ACA. For HSA-qualified plans in 2018, it’s $6,650 for individuals and $13,300 for families, as opposed to the general market rules that limit out-of-pocket spending to $7,350 for individuals and $14,700 for families.

The 2018 contribution limits for HSAs are $3,450 if you have individual coverage, and $6,900 if you have family coverage under an HDHP.

Health savings accounts get mixed reviews

The country is largely split over the question of whether health savings accounts are a wise coverage solution on a large scale – and whether HSAs help or hurt the nation’s health care system.

Proponents of HSAs argue that people tend to be more careful with their own health care costs when they’re paying part of the bills themselves. So instead of going to a doctor for every cough, cut or cramp, HSA users would have an incentive to be less wasteful with their health care spending, and maybe even take the time to shop around.

They say that the cumulative effect will be a nation of health consumers whose behavior would lower health care costs, while injecting price and quality competition into the medical marketplace. And tax advantages, they say, could lure the uninsured into lower-cost, high-deductible plans, reducing the ranks of the uninsured and possibly even nudging them into healthier lifestyles.

Critics of HSAs argue that health savings accounts benefit the young and healthy, while those with regular medical problems or who are older may end up paying more if they select an HDHP/HSA combination, because they tend to drain their savings with more frequent up-front medical expenses. But this would be true of any comparison between higher-deductible plans (generally favored by healthier people) and lower-deductible plans.

Another argument is that the tax-advantaged option constitutes a tax shelter for the rich, and that low-income families don’t earn enough to benefit from the tax breaks. Further, skeptics warn that many people with HSA plans — and especially the poor — might be reluctant to spend money from their savings account, even on necessary healthcare expenses. Although a reduction in spending on unnecessary care would be beneficial, it’s often hard for a consumer to know what care is necessary and what’s unnecessary, and skimping on the former could lead to higher-cost problems later.

But it’s worth noting that the ACA requires all plans — including HSA-qualified plans — to cover preventive care with no cost-sharing. So all HSA-qualified plans effective January 2014 or later, cover the full range of recommended preventive care before the deductible.

Accounts are becoming mainstream

Enrollment in HSA-qualified HDHPs has soared to 20.2 million people by 2016, up from 19.7 million people in 2015 (more than three-quarters had HDHP coverage provided by a large employer). This is up from 10 million consumers in 2010 and according to data from America’s Health Insurance Plans (AHIP), enrollment has been growing at a rate of about 15 percent per year since 2011. AHIP’s data indicates that 8 million individuals were enrolled in HSAs in 2009 and just 3.2 million in 2006. Not all of those enrollees contribute funds to an HSA, but they’re eligible to do so if they want.

Many businesses, large and small, offer these HDHP policies to their employees, but you can also purchase them on your own through the exchange in your state or directly from a health insurance carrier. HealthCare.gov introduced optional standardized plans for 2017, and for 2018, they expanded the standardized plan selection to include an HSA-qualified HDHP.

In the Benefit and Payment Parameters for 2019, HHS eliminated the standardized plan designs for 2019, and is encouraging insurers to offer HDHPs. The agency also wants to pursue adjustments to the plan display information on HealthCare.gov in order to “promote the availability of HDHPs,” although nothing was included in the final regulation about how that would be accomplished (HHS noted that they “will take [the comments they received on this issue] under consideration.”) But clearly, HDHPs and HSAs are a focus for the current Administration.

Health insurance companies will generally recommend a bank that insureds can use to establish an HSA once they’re enrolled in an HDHP, but enrollees are free to select any HSA custodian they like. A long list of banks, credit unions, and brokerage firms offer accounts for saving and growing HSA funds over time, so shop around before you select an HSA custodian. The saving accounts include a dizzying array of options. And brokerages offer countless stocks, bonds and funds to invest in with low trading fees, while others may have limited choices, are more expensive, and have hidden fees.

HSAs play a bigger role under GOP health care reforms, but nothing has changed yet

Republicans in Congress spent much of 2017 focused on their efforts to repeal and replace the ACA, but their efforts stalled in late July when Senate Republicans failed to pass three different versions of the ACA repeal bill that the House had passed in May, and a last-ditch attempt in September to repeal the ACA also failed in the Senate.

There is little doubt that Congressional Republicans will continue to try to repeal and replace the ACA if they’re able to muster enough votes to do so, but for the time being, the ACA remains fully intact.

All of the health care bills the GOP considered in 2017 included reforming HSAs to allow for larger contributions, lower penalties, and more latitude in terms of use of HSA funds. Even the Senate’s “skinny” repeal bill —which was only eight pages long and was a last-ditch effort to pass something that could lead to a conference committee with House Republicans — included HSA reform.

Some GOP proposals called for partial government funding of HSAs, others would have allowed people to contribute more to their HSA (which critics note is likely to be much more beneficial for the wealthy than for the poor), and would allow more people to contribute to HSAs. Former Georgia Representative Tom Price, who headed HHS for several months in 2017, introduced legislation in 2015 to replace the ACA, and it relied heavily on HSAs (it did not pass).

With the current political leadership, HSAs are certainly here to stay. And they may be enhanced in some way under the Trump Administration. But for the time being, nothing has changed. Republican lawmakers have tried to increase contribution limits for HSAs, reduce the penalty for under-65 withdrawals for non-medical expenses, allow HSA funds to be used for over-the-counter medications, and allow HSA funds to be used to pay health insurance premiums (currently that only works for COBRA premiums, Medicare premiums, long-term care premiums, or health insurance premiums paid while the person is receiving unemployment benefits). But as of early 2018, none of the measures have passed, and the rules governing HSAs remain unchanged.


Louise Norris is an individual health insurance broker who has been writing about health insurance and health reform since 2006. She has written dozens of opinions and educational pieces about the Affordable Care Act for healthinsurance.org. Her state health exchange updates are regularly cited by media who cover health reform and by other health insurance experts.

Related terms

health savings account (HSA)