What Is an HSA and How Does It Work?

A Health Savings Account, or HSA, is a special bank account designed to help people save money for medical expenses. Unlike a regular savings account, an HSA offers tax advantages that can make your healthcare dollars stretch further. To understand HSAs, it helps to know how they differ from other ways people pay for healthcare.

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When you put money into an HSA, you don't pay federal income taxes on that money. This means if you earn $50,000 per year and contribute $4,000 to an HSA, you only pay income taxes on $46,000. The money you save on taxes can be significant—potentially $800 to $1,200 per year, depending on your tax bracket. That's real money you keep instead of sending to the government.

The money in your HSA can be used to pay for qualified medical expenses right away, or you can let it sit and grow. Unlike a Flexible Spending Account (FSA), which forces you to spend the money or lose it each year, HSA money rolls over. After you turn 65, you can withdraw money for any reason without penalties, though non-medical withdrawals before 65 do face a 20% penalty plus taxes.

According to the U.S. Internal Revenue Service, over 30 million people had HSAs as of 2022, with the average account balance around $2,000 to $3,000. However, some account holders who use their HSAs strategically have built balances exceeding $30,000 by saving and investing the funds over time.

HSAs work alongside high-deductible health plans (HDHPs). An HDHP is health insurance with a lower monthly payment but a higher amount you must pay out-of-pocket before insurance kicks in. For 2024, an HDHP deductible must be at least $1,600 for individual coverage or $3,200 for family coverage. If your insurance plan meets these requirements, you may be able to open an HSA.

Practical takeaway: An HSA combines tax savings with flexibility. The money is yours to keep, grows year after year, and can be invested like a retirement account. This makes it different from spending-it-or-lose-it accounts and worth considering if your health insurance structure allows it.

HSA Bank Account Features and What to Look For

HSA banks are financial institutions that offer HSA accounts. These accounts have specific features you should understand when choosing where to keep your HSA money. Not all banks offer HSAs, and those that do may have different rules and costs.

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When evaluating an HSA bank, consider these key features. First, look at monthly maintenance fees. Some banks charge $0 per month, while others charge $3 to $5. Over ten years, a $5 monthly fee adds up to $600 that could have stayed in your account. Second, examine what you can use the money for. All HSAs allow deductible payments, copays, and coinsurance. Many also allow over-the-counter medicines, dental work, vision care, and mental health services. The IRS publishes a detailed list of over 200 qualified medical expenses.

Third, investigate investment options. Some HSA banks let you keep money in a cash account earning minimal interest—around 0.01% to 0.05% per year. Others allow you to invest in mutual funds or index funds, which historically return 7% to 10% annually over long periods. If you're young and won't need the money soon, investing can significantly grow your HSA. A 30-year-old who invests $3,850 yearly in an HSA earning 8% average returns could have over $1 million by age 65.

Fourth, check withdrawal methods. Does the bank offer a debit card? Can you reimburse yourself? Can you withdraw money online, by phone, or only in person? Some banks make withdrawals simple; others require paperwork. Fifth, consider customer service quality. Read reviews about wait times and how well the bank handles questions.

Many HSA banks also offer educational resources. They may provide lists of qualified medical expenses, tax documents at year-end, and calculators to help you plan contributions. These tools have no cost but can save you time and prevent mistakes.

Practical takeaway: Spend time comparing HSA banks before choosing one. Low or zero monthly fees, clear withdrawal processes, and investment options matter most. The bank you pick should align with whether you plan to spend the money soon or invest it for the future.

Tax Advantages and How They Save You Money

The tax benefits of an HSA are the biggest reason people choose this account over regular savings. Understanding these benefits can help you see concrete examples of how much money you might save.

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HSAs offer what's called a "triple tax advantage." First, money you contribute reduces your taxable income—you don't pay federal income tax on HSA contributions. Second, the money inside your HSA grows without being taxed. If you invest $4,000 and it earns $200 in investment gains, you don't pay tax on that $200. Third, when you withdraw money to pay for qualified medical expenses, you don't pay tax on the withdrawal. No other savings account offers all three benefits together.

Let's look at a real example. Sarah earns $60,000 per year and is in the 22% federal tax bracket. She contributes $3,000 to her HSA. She saves $660 in federal taxes right away ($3,000 × 22%). Her employer may also offer to deduct HSA contributions from her paycheck before taxes, which also saves 6.2% in Social Security taxes and 1.45% in Medicare taxes—another $238. Total tax savings: $898 on a $3,000 contribution.

Over 30 years, if Sarah contributes the maximum allowed each year and her HSA averages 6% annual returns, she could accumulate over $500,000. She'd never pay taxes on the investment earnings or on withdrawals for medical costs. Compare that to a regular savings account where she'd pay taxes on interest earned and contribute with after-tax money—the difference is substantial.

State taxes matter too. Most states don't tax HSA contributions, but a few do. New Hampshire and Tennessee have specific rules. If you live in a state with high income taxes, HSA benefits are even larger. Someone in California saving $5,000 to an HSA might save $1,500 or more in combined federal and state taxes.

The IRS sets contribution limits each year. For 2024, you can contribute up to $4,150 for individual coverage or $8,300 for family coverage. Self-employed people and those over 55 can contribute additional amounts. These limits are designed to prevent people from sheltering too much income from taxes.

Practical takeaway: HSA tax savings typically range from 25% to 35% of your contribution, depending on your tax bracket. Over decades, this tax-free growth and tax-free withdrawals create substantial wealth compared to regular savings accounts. Calculate your personal tax rate to see your specific savings.

Qualified Medical Expenses You Can Pay For

HSA money can only be used for specific medical expenses defined by the IRS. Understanding what qualifies helps you plan your HSA strategy and avoid paying taxes on withdrawals for non-qualifying expenses.

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The list of qualified expenses is longer than most people realize. Obviously, it covers doctor visits, hospital stays, surgery, and prescription medicines. But it also covers many other items. Dental work qualifies—cleanings, fillings, root canals, orthodontics, and dentures. Vision care qualifies—eye exams, glasses, contacts, and LASIK surgery. Mental health services, including therapy and psychiatry, count as qualified expenses.

Over-the-counter medicines are qualified if you have a prescription. Aspirin, allergy medicine, pain relievers, and cold medicine all qualify if a doctor prescribed them. Without a prescription, they don't qualify—a common source of confusion. However, medical equipment like crutches, wheelchairs, hearing aids, blood pressure monitors, and insulin pumps all qualify without a prescription.

Here's a broader list of qualified expenses:

  • Acupuncture and chiropractic care
  • Ambulance services