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What is a Health Savings Account (HSA)?

Updated: Sep 7, 2023

A Health Savings Account (HSA) is a tax-advantaged personal savings account that can be used to pay for current and future medical expenses. It is an alternative to traditional health insurance and is often paired with a high-deductible health plan (HDHP).

How does an HSA work?

To be eligible for an HSA, you must be enrolled in an HDHP. These plans typically have lower premiums compared to traditional health insurance plans, but higher deductibles. The HSA is meant to cover the expenses that are not covered by the HDHP until the deductible is met. If you are looking for an HSA Provider, check out Lively, and check out our full review of Lively to learn more about the platform.

HSAs have three main components:

  1. Contributions: You or your employer can contribute pre-tax dollars to your HSA. These contributions are tax-deductible and can be used to pay for qualifying medical expenses.

  2. Accumulation: The funds in your HSA accumulate over time, and any unused funds roll over from year to year.

  3. Withdrawals: You can use the funds in your HSA to pay for qualifying medical expenses at any time. Withdrawals for non-medical expenses are subject to income tax and may incur a 20% penalty if you are under the age of 65.

What are the benefits of an HSA?

There are several benefits to using an HSA:

  1. Tax benefits: Contributions to your HSA are tax-deductible, and any earnings on the funds in your HSA are tax-free.

  2. Savings: Since HSAs are paired with an HDHP, you may save on monthly premiums compared to traditional health insurance plans. Additionally, the funds in your HSA can accumulate over time, providing a source of savings for future medical expenses.

  3. Flexibility: You can use the funds in your HSA to pay for a wide range of qualifying medical expenses, including prescription drugs, dental and vision care, and even some over-the-counter medications.

  4. Portability: Your HSA is portable, meaning it stays with you even if you change jobs or insurance plans.

What are the risks of an HSA?

HSAs are not risk-free. They are investment accounts that grow via the same mechanisms as the stock market. You are buying part of an organization hoping it will grow over time, and in turn, your HSA account will grow over time with it. Below I've listed some other risks involved with an HSA account.

  1. Investment risk: If an HSA offers investment options, there is a risk of losing money due to market fluctuations.

  2. Lack of flexibility: Funds in an HSA must be used for qualified medical expenses, or else they may be subject to taxes and penalties.

  3. Limited funds: Unlike traditional health insurance, an HSA may not provide enough funds to cover all medical expenses.

  4. Inflation risk: The cost of health care is rising faster than the general rate of inflation, meaning the funds in an HSA may not be enough to cover future expenses.

  5. Misuse of funds: If HSA funds are used for non-qualified expenses, they may be subject to taxes and penalties.

Who is eligible for an HSA?

To be eligible for an HSA, you must meet the following criteria:

  1. You must be enrolled in an HDHP.

  2. You cannot be enrolled in any other type of health insurance plan that provides first-dollar coverage (coverage that pays for medical expenses before the deductible is met).

  3. You cannot be enrolled in Medicare or be claimed as a dependent on someone else's tax return.

If you meet these criteria and are considering an HSA, it is important to carefully review the terms of your HDHP and determine if an HSA is a right choice for you.

What are HSA-qualified medical expenses?

Qualified medical expenses for an HSA include a wide range of health care costs such as:

-Doctor visits

-Prescription drugs

-Dental and vision care

-Psychiatric care

-Physical therapy

-Chiropractic services

-Hospital bills

-Lab fees


-Long-term care

-Some over-the-counter medications (with a doctor's prescription)

It's important to check with the IRS for a complete list of eligible expenses.

How does my HSA grow over time?

  1. Contributions: Account holders and/or their employers can make tax-deductible contributions to the HSA.

  2. Interest and dividends: Like any savings account, HSAs can earn interest on the balance, and some HSAs also offer investment options such as mutual funds, which can potentially earn higher returns.

  3. Capital gains: If investments are held within the HSA, capital gains may be earned when investments increase in value.

The account balance rolls over from year to year, allowing the account to grow over time, tax-free.

I hope this article helps to explain what a health savings account is and how it works. If you have any additional questions, feel free to ask.

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