Q: What Is an HSA?

An HSA, or health savings account, is a type of tax-advantaged account where you can put money if you have a high deductible health plan (HDHP).

You can use the money in the HSA to pay for future medical expenses, or you can use it as a retirement account, depending on your goals.

What are some HSA benefits?

There are lots of advantages to having an HSA.

The money you put into an HSA is pre-tax, which means every cent you put into an HSA is one less cent in your taxable income. The money in your HSA can also be invested in the stock market or an interest-bearing account, and gains are not taxed by the IRS. (While the IRS does not tax your contributions or gains, some states do. So make sure to consult your accountant.)

As long as you use the money for qualified medical expenses, that money also comes out of your account tax-free. Qualified medical expenses include costs like dental and vision care, infertility treatment, and long-term care.

Plus, there’s no “use it or lose it” rule like there is with an FSA. Whatever you don’t use just rolls over from one year to the next.

As a bonus, your HSA can serve as a backup retirement account. Once you turn 65, you can take money out of your HSA to spend on anything you want. You simply pay income tax on the withdrawal if it’s not for qualified medical expenses.

What do I need to do to open an HSA account?

You have to have health coverage under an HSA-qualified HDHP in order to make contributions to an HSA. Employers can offer HDHPs and HSAs together, but they do not have to. You can also open up your own HSA.

Once you have money in your HSA, you can withdraw from it to pay for medical expenses at any time, even if you’ve switched to a health plan that isn’t an HDHP.

What are the HSA contribution limits?

The HSA contribution limit in 2023 is $3,850 for an individual with HDHP coverage and $7,750 for family HDHP coverage. For HSA account holders age 55 or older, the contribution limit is $1,000 higher than the individual or family limit.

Employers can also contribute to their employees’ HSAs, but the total contribution amount—from the employee, the employer, and anyone else who contributes to the employee’s account—can’t be more than those limits.

If employers choose to contribute to employees’ HSAs, they have to do so in a way that’s non-discriminatory. Contributions can also only be made if the employee has coverage under an HSA-qualified high-deductible health plan (whether or not that plan is employer-sponsored).

How does the HSA penalty work?

If you switch to an HDHP partway through the year, you can still deposit the maximum contribution amount for that year into an HSA, instead of having to prorate your contribution.

But if you make the full-year contribution instead of a prorated amount, you must continue to have HDHP coverage for the entire following year.

If you end up dropping your HDHP coverage partway through the following year, you’ll have to pay taxes and a penalty on some of the money you contributed to your HSA during the year when you didn’t have HDHP coverage the entire year.

Here’s how this works: The IRS would look at how much you would have been allowed to contribute on a prorated basis (for the months when you had HDHP coverage) and subtract it from the amount you actually contributed. The difference will be included in your taxable income and will also be subject to a 10 percent penalty.

So if you enroll in an HDHP mid-year, you’ll want to weigh your options in terms of how much to put in your HSA that year.

If you’re confident you’ll continue to have HDHP coverage throughout the following year, you can benefit tax-wise by contributing the full annual contribution amount to your HSA. But if you think you might not continue to have HDHP coverage throughout the following year, you may want to consider sticking to a prorated HSA contribution.