Use a Health Savings Account (HSA) to Save Money

One of the best things you can do to pay less tax every year is to set up a health savings account and make maximum contributions. An HSA is a tax-advantaged medical savings account available to taxpayers who are enrolled in a high-deductible health plan (HDHP). It is a type of savings account that lets you set aside money on a pre-tax basis to pay for qualified medical expenses. High-deductible plans usually have lower monthly premiums than plans with lower deductibles. By using the untaxed funds in an HSA to pay for expenses before you reach your deductible and other out-of-pocket costs like copayments, you reduce your overall health- care costs.

A health savings account is not the same as a flexible spending account. With the latter you must “use it or lose it” by year’s end. With an HSA, the funds accumulate year to year like a regular savings account. An HSA also may earn interest.

Advantages of an HSA

  • Funds contributed to an HSA are not subject to federal income tax at the time of deposit. In other words, they lower your taxable income.
  • Money in the savings account can be used to pay your insurance deductible, tax free.
  • Withdrawals to pay qualified medical expenses that are not part of your deductible, like dental and vision expenses, are also tax free.
  • Money left in the savings account at the end of the year earns interest and is yours to keep. (Some plans allow you to invest your savings in stocks and mutual funds.) 
  • Money and compound interest grow tax-deferred. If interest is used to pay qualified medical expenses, it’s also tax-free.
  • High-deductible insurance plans usually have lower premiums, so you save money there too.

Disadvantages of an HSA

  • You can only set this up if you are paying your own insurance. If you have insurance some other way, such as via your spouse, you can’t participate in an HSA. (Note: If you’re married, check to see if your spouse’s company offers a high-deductible HSA insurance option and take advantage of it.)
  • Early and non-medical withdrawals are taxable income and also subject to a steep 20% tax penalty. (When you reach 65 or if you become disabled, you can withdraw HSA funds for non-medical reasons without penalty, but the amounts withdrawn will be taxable as ordinary income.)
  • Most HSAs charge a management fee, similar to bank fees (for example, $2.50 per month).
  • You can’t take a loan from an HSA like you can from a 401(k).

Although the annual contribution limits are fairly low, it's still worth doing to lower your taxes and increase your savings. The contribution limits for 2022 are $3,650 for an individual ($3,600 for 2021)  and $7,300 for a family ($7,200 for 2021). If you’re over 55 you can contribute $1,000 more. (Important note: If you are divorced and your kids have health insurance through your ex-spouse, you can still contribute at the family limit.)

Here’s a scenario to consider: you decide to use the HSA as an investment account to squirrel away money for medical expenses in retirement. In other words, you don’t take any withdrawals for expenses before then. You contribute the maximum family amount every year for 15 years and get a 4% rate of return. After the 15 years, you will have $153,543 to use, tax-free, for your medical expenses, including Medicare Part B and Part D premiums and a portion of long-term-care premiums, depending on your age. That’s significant, especially when it’s estimated that a 65-year-old retired couple will need $260,000 to cover their likely health costs. The money in a HSA can be used to pay those costs tax-free. Accumulating money in a HSA has a distinct advantage over an IRA, since IRA withdrawals will be taxed.

In summary, health-savings accounts amount to a triple play of benefits—deposits are tax-free, withdrawals for medical-related expenses are tax-free, and interest grows tax-deferred. Their major drawback? They have lots of rules and restrictions. It’s fairly easy to set one up; many banks and brokerage firms offer health savings accounts, and you can open an account anywhere as long as you have an HSA-eligible, high-deductible health insurance policy. Finding and getting the health insurance policy is the hard part.

More Information

For general information and FAQs about HSAs, we recommend the HSA Center website.

For a good summary of the tax advantages of an HSA vs. other savings plans, we recommend this Morningstar article.

To find an HSA plan that best fits your needs (for example, paying current medical expenses or saving for retirement), try this website where it’s easy to compare any of 357 providers.