Senate Cents: A Financial Wellness Blog

Key takeaways

• A health savings account (HSA) is a tax-advantaged account that can be used to cover qualified medical expenses now or in the future.
• HSAs are designed to work together with an HSA-eligible high-deductible health plan (HDHP) offered by an employer.
• Because of its possible tax advantages, an HSA can be looked at as both a way to pay and save for medical expenses and a savings vehicle for retirement.
• If you start contributing to an HSA when you are younger, you have more time to take advantage of its tax-advantaged savings potential.

You might not even know what an HSA is, and that's OK! Here, we will cover the basics and tell you why opening a health savings account (HSA) is something to do sooner rather than later.

Money saved in an HSA can help pay for out-of-pocket expenses in case of medical emergency and can be a significant part of your retirement savings. The possible tax advantages of an HSA can help you get the most bang for your buck not just for medical expenses today but also for saving for retirement.

So what is an HSA anyway?

A health savings account (HSA) is a tax-advantaged account that can be used to cover qualified medical expenses. HSAs are designed to work together with an HSA-eligible high-deductible health plan (HDHP) offered by a employer. Through this employer benefit, you can typically opt into contributing money from each paycheck into a HSA. These contributions live in an account that can be used to pay for qualified medical expenses, like going to the doctor or buying prescriptions. Money in an HSA can also be invested. Employers can also contribute to your HSA as part of the benefit.

When used for qualified medical expenses, the money from an HSA is triple tax-advantaged. This means you may not have to pay any federal taxes on contributions, capital gains taxes from investment growth, or any taxes on withdrawals if the money is used for qualified medical expenses.¹

Starting at age 65, there is no penalty if you use HSA money for nonmedical expenses. You will have to pay income tax though, similar to pre-tax withdrawals from your 401(k). There is also no "use it or lose it" rule as there is in health flexible spending accounts (FSAs). Funds remain in your account year to year, and any unused funds may be used to pay for future qualified medical expenses.

Why is an HSA important?

The tax advantages of an HSA can help you get the most value out of your earned dollars as a tool for both health expenses and retirement.

Let's look at an example. An individual in the 22% federal income tax bracket could potentially save nearly 30% in taxes (federal income + FICA + potentially state income) on each dollar contributed to the HSA through a pre-tax plan. And that doesn't even take into account any investment growth of that money in your HSA, which you would also likely not have to pay taxes on.

That money could be used in the short term as part of your budget for health care costs—for a trip to the doctor or another qualified medical expense not covered by your health plan. Or, that money could be saved and invested for health care costs when you are older (when you are likely to have more health care needs) or as part of you savings for retirement. An HSA can help make sure you have savings for medical costs, and help you get the most bang for your buck when saving for retirement.

Read Viewpoints on Fidelity.com: 5 ways HSAs can fortify your retirement

How do I know if I'm eligible for an HSA?

You're eligible to open and contribute to an HSA if:

• You're covered by an HSA-eligible health plan on the first of the month
• You're not covered by an ineligible health plan
• You're not enrolled in Medicare
• You cannot be claimed as a dependent on someone else's tax return

What is an HSA-eligible health plan?

For 2022, the IRS defines HSA-eligible plans as high-deductible health plans (HDHPs) with a deductible of at least $1,400 for an individual and $2,800 for families. These health plans must also have an annual out-of-pocket maximum spending amount of no more than $7,050 for an individual and $14,100 for families.²

High-deductible health plans could be compelling to those with minimal health expenses. Typically with a high-deductible plan your insurance premium is lower. You could look at it as instead of paying the insurer every month, you are paying yourself by contributing money to your HSA.

The nuts and bolts of contributing to your HSA

The 2022 IRS contribution limits for an HSA are $3,650 for individual coverage and $7,300 for family coverage.²

Your employer may also contribute to your HSA, although its contributions may look a little different. While employers may have different rules and timing for their contributions, a common approach is for employers to deposit their full annual contribution into your account at the beginning of the year or as soon as you enroll in the HSA-eligible health plan and open your HSA.

Although typically HSA plans take contributions in the form of pre-tax income from paychecks (similar to contributions to a 401(k)), depending on the plan an HSA can also be funded with after-tax dollars, which the individual then takes as a tax deduction on their personal taxes. You can also open an HSA with Fidelity.

Investing in your HSA

If you invest the money in your HSA, you are putting your money in a position where it can potentially grow. How much to invest and how to invest depends on your personal situation, considering your goals, time horizon, financial situation, and risk tolerance. To learn more about investing in your HSA, read Viewpoints on Fidelity.com: Ways to invest in your health savings account.

It may seem odd to start planning for medical costs when you are young and may not have had many health-related costs. Even though your healthcare costs may be low today, they are likely to be higher when you are older. And the possible tax advantages of an HSA make it more than just a way to pay for qualified medical expenses—it is also a vehicle to save for retirement in general.

If you choose to use Fidelity for your HSA, you can choose to actively manage your HSA investments in an HSA brokerage account, or you can work with a financial advisor to learn more about HSA investing with Fidelity.

This article originally appeared on Fidelity.com on January 3, 022. 

1. With respect to federal taxation only. Contributions, investment earnings, and distributions may or may not be subject to state taxation. Please consult with your tax advisor regarding your specific situation.

2. IRS Revenue Procedure 2021-2025

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.