What Is A Health Savings Account & How Does It Work?

Health savings accounts (HSAs) are a great way to save and plan for your future health needs. But how do health savings accounts work, and how are they different from regular savings or retirement accounts? And most importantly, how can you use your HSA to pay for long-term care and other medical expenses? 

LTC News wants to keep you updated on the latest long-term care information. We work with LTC Insurance experts to get the most accurate educational information possible. We want to help everyone learn more about long-term care and feel more confident in their care decisions. 

In this article, we’ll define health savings accounts and explain how these accounts work. We’ll also discuss specific HSA limits, tax incentives, and how to open and use your HSA to pay for care. 

What Is A Health Savings Account (HSA)?

A health savings account (HSA) is a tax-advantaged way to save and plan for future health expenses. You can use an HSA to pay for various care costs ranging from hospital visits to Long-Term Care Insurance premiums – more on that later. 

Any money contributed to an HSA is pre-tax, meaning you don't pay federal income taxes on contributions. Employers or trusted individuals are also eligible to contribute to your HSA. Their contributions do not count towards your income either, making those contributions tax-free. 

Contributions to your HSA can grow and gain interest through investments. Any money gained from interest is tax-deferred, meaning you only pay taxes once you withdraw money, depending on what you use the withdrawn amount for.  

You can access your money anytime when you need help paying for health expenses. Any money used to pay for qualified medical expenses will come from your account completely tax-free. HSA money used for non-qualified medical expenses will be subject to federal income taxes and potentially additional fees. 

You'll never lose the money in your account, even if you switch jobs, retire, or wait years before using your HSA. 

Health savings accounts can help individuals plan for retirement by offering tax-free avenues to save. This savings method maximizes accessible income to cover care costs and minimizes annual tax bills.

Flexible Savings Account (FSA) vs. Health Savings Account (HSA): Key Differences

You may have heard the term "flexible savings account." Many people confuse FSAs for HSAs because they’re both tax-advantaged savings accounts used for qualified medical expenses. However, there are some critical differences between the two accounts.  

Flexible savings accounts (FSAs) are joint individual and employer-based accounts. Individuals and their employers can contribute pre-tax money to their FSA. There are contribution limits for FSAs, but these limits are lower than HSAs. 

Money contributed to an FSA has the same tax-free elements as HSAs, meaning it will be tax-free if used for qualified medical expenses. But that's where their similarities end. 

Ironically, flexible savings accounts are far less flexible than health savings accounts. FSAs are "use it or lose it," meaning the money in your FSA will reset at the end of each year. You will also lose any existing FSA money if you switch jobs. 

HSAs work very differently. You will always keep the money in your account, whether you switch jobs or wait years to use it. Here’s a table to illustrate more differences:

What’s The Difference Between A Flexible Savings Account (FSA) vs. A Health Savings Account (HSA)?

How Does A Health Savings Account Work?

With the definition out of the way, let’s dive deeper into how health savings accounts function. HSAs are a great resource to save, but they’re nuanced and unique accounts with restrictions and requirements. 

For example, you must meet specific requirements before you can open an HSA. Individuals with existing HSAs must meet similar requirements to continue contributing to their accounts.

Regardless of these rules, if you already have an account, you can never lose it. There are no time limits or job restrictions for HSAs. Once you have the HSA, it’s yours to keep even if you leave your employer or retire. 

How To Open An HSA

To open an HSA, individuals must meet specific requirements. These can include:

• Enrollment in an HDHP – To qualify for an HSA, individuals must have a high-deductible health plan. In the next section, we'll explain HDHPs and their relation to HSAs.

• No other health insurance coverage outside of an HDHP – Individuals generally aren't allowed to have any other health insurance besides their high-deductible health plan. However, other types of insurance, like Long-Term Care Insurance, are allowed. 

• Dependency status on taxes – Individuals claimed as dependents on someone else's taxes generally cannot open their own HSA. 

• U.S. residency or citizenship – Individuals must have U.S. citizenship or permanent residency to open an individual HSA account. 

What Is A High-Deductible Health Plan?

Individuals must have a high-deductible health plan (HDHP) to qualify for or start a health savings account. But what is considered a high-deductible health plan?

A high-deductible health plan is a private health insurance plan with a high deductible and usually a low monthly premium. 

A deductible is the out-of-pocket amount of money a policyholder is responsible for covering each year. After the policyholder has paid the deductible, their insurance company will cover the rest of their qualified out-of-pocket medical expenses for the remainder of that year.  

For example, if your deductible were $1,800, you'd be responsible for covering $1,800 in medical expenses that year before your insurance policy would start covering your costs. Monthly HDHP premiums do not count towards this limit. 

High-deductible health plans can be defined by their minimum deductible amount. The IRS sets these minimums to determine which plans do and don't qualify as an HDHP and whether your HDHP qualifies you to open an HSA. Here are the requirements:

Deductible Minimums For High-Deductible Health Plans in 2024

High-deductible health plans and health savings accounts were designed to complement each other. HDHPs offer low premiums but put policyholders at risk of high yearly out-of-pocket expenses. HSAs offer tax incentives to help to mitigate and plan for high yearly costs. 

Many employers offer high-deductible health insurance plans with HSAs to lower the premium for their employees. Some employers will contribute money to the HSA to help cover the cost of deductibles, and others will match your contribution. Self-employed individuals can also open an HSA if they have a high-deductible health insurance plan. 

In addition to an HSA, the IRS limits the total yearly out-of-pocket medical expenses for individuals with HDHPs. This protects these policyholders from excessively expensive health care costs. 

Any medical expense traditionally covered by the insurance policy counts towards this limit. Other expenses like health insurance premiums or non-covered medical bills do not count towards this limit. 

The Maximum Amount Policyholders Are Responsible for Paying Out-of-Pocket with a High-Deductible Health Plan

What Are HSA Contribution Limits in 2024?

There are restrictions on how much and when you can contribute money to an existing HSA. Individuals with existing HSAs may be barred from contributing pre-tax money to the account if: 

• They have existing Medicare coverage – Individuals with Medicare coverage are not eligible to continue contributing money to their HSA. However, Medicare coverage does not prevent the individual from withdrawing HSA money to use on medical expenses. 

• They're eligible for Veteran Affairs benefits – In general, individuals receiving benefits from the VA cannot contribute more money to their HSA. However, if the individual has an existing HSA, they can still use that money to cover care costs. 

The same restrictions discussed in the previous "How To Open an HSA" section also apply here. So if you:

• Are no longer enrolled in an HDHP

• Have a non-HDHP health insurance plan

• Are claimed as a dependent

• Are no longer a U.S. resident or citizen

If any of the above apply to your situation, then you may no longer be eligible to contribute to your HSA. 

This does not prevent you from withdrawing money from your HSA. You will always have your HSA regardless of whether your eligibility to contribute more pre-tax money changes. 

If you're still eligible to contribute pre-tax money to your HSA, you should look for the contribution limits set by the IRS.  

These limits apply to the total amount contributed each year. Remember, there are different limits depending on age and whether your HSA is individually or family-owned. 

Total HSA Contribution Limits in 2024

As you may have noticed, individuals aged 55 and older can contribute an additional $1,000 on top of the initial limit. This is also known as a catch-up contribution amount. 

The IRS offers catch-up contributions to help older individuals approaching retirement age save more for future care needs. It can benefit those planning an early retirement who may not have Medicare coverage yet. This increase also aligns with other retirement plans and encourages more planning on the retirees’ part. 

What Are The Tax Benefits of A Health Savings Account?

Health savings accounts are widely considered triple tax-advantaged. In other words, HSAs qualify for:

• Tax-deductible or pre-tax contributions.

• Tax-deferred interest or investment growth.

• Tax-free withdrawals for qualified medical expenses.

Let's start with tax-deductible contributions. Health savings account contributions can be tax deductible or pre-tax money, depending on how you make the contributions. Here is a brief explanation:

When contributing money to your HSA from your paycheck, you cannot deduct the contribution on your tax return. This is because the contributions are made with pre-tax money, meaning they are excluded from your gross income and not subject to federal income tax, reducing your taxable income and tax liability.

When contributing money to your HSA directly, such as from your bank account or by writing a check, you can deduct the contribution amount from your taxes. This is because the contributions are made with after-tax money, meaning they are included in your gross income and subject to federal income tax. However, you can claim an above-the-line deduction for the amount you contributed, lowering your adjusted gross income and tax liability.

After contributing, you're free to invest your HSA funds. Invested HSA money can grow and gain interest tax-deferred. Tax-deferred means you won't pay yearly taxes on your earnings. You won't pay any fees or federal income taxes on these extra earnings if you withdraw the money for qualified medical expenses. 

Any withdrawals, at any age, made for a qualified medical expense are tax-free. 

For those 65 and older, any money withdrawn for a non-qualified medical expense is subject to federal income tax. For those under 65, any money withdrawn for a non-qualified medical expense is subject to federal income tax and a 20% fee.  

How To Use Your HSA To Cover The Cost Of Care

Health savings accounts can help you cover your care costs as long as you still have money available and you're using the money for qualified medical expenses. In the next section, we'll explain what qualified medical expenses are. 

Many HSAs come with a debit card that you can use to pay for medical expenses. Those who opt to pay in other ways can use their HSA money to reimburse themselves for the cost of care. 

It's also worth noting that you can use your HSA to cover yourself and your spouse and dependents. So, what exactly can your HSA cover without tax consequences?

What Are Qualified Medical Expenses? (What Can You Use Your Health Savings Account For?)

You can use your health savings account to pay for a wide array of medical or health-related expenses. But not every expense is eligible to be covered. 

In order for your HSA to cover your bill, the expense needs to be a qualified medical expense. The IRS's publication 502 defines a qualified medical expense as:

the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body.

Some examples of qualified medical expenses include:

• Long-Term Care Insurance premiums

• Medicare supplements (for individuals 65 and older)

• Please note: this does not include Medicare Part A

• Prescription or over-the-counter drugs prescribed by doctors

• Doctor visits, including specialists

• Dental care

• Vision care

• Hospital stays and expenses

• Outpatient or rehabilitative services

• Associated medical costs like transportation or supplies

• Lab work

• Preventative care and screenings

What Are HSA Withdrawal Rules?

If you use your HSA money to pay for a qualified medical expense, you can withdraw your money completely tax-free. 

But what happens when you use HSA money on something that isn’t a qualified medical expense? Technically, you’re allowed to do this, but you’ll end up paying more in taxes. 

If you’re under age 65, you’ll pay federal income taxes and a 20% tax fee on any withdrawn amount not used on a qualified medical expense. 

After age 65, you can use your HSA for anything you would use a traditional IRA or 401(k). For example, you can use your HSA to pay for retirement expenses, such as living expenses or travel.

However, you will pay income taxes on HSA money withdrawn to pay for non-qualified medical expenses. There is no 20% fee for individuals aged 65 or older.  

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How To Use Your HSA To Pay For Long-Term Care & Long-Term Care Insurance Premiums 

Unfortunately, for those in need of help with long-term care, HSAs do not directly cover long-term care costs. Long-term care is defined as help with personal care needs, a need for supervision due to cognitive decline, or a need for help with two or more activities of daily living. 

This does not directly relate long-term care to the definition of a qualified medical expense. Therefore, much of long-term care does not count as a qualified medical expense for an HSA. Instead, health savings accounts can help with associated or related long-term care costs. 

For example, your HSA cannot cover room and board costs at a nursing home or assisted living facility. But your HSA will cover the cost of any medical care you receive at these facilities. Medical care can include doctor visits, specialist appointments, or other forms of skilled care. 

Your HSA may also be able to cover medical assistive equipment such as hearing aids, wheelchairs, or other mobility-aiding devices. You can also use your HSA to cover the costs of both prescription and non-prescription medications. 

Although you can’t use your HSA to pay for long-term care directly, you can use your HSA to cover your Long-Term Care Insurance premium. 

When you have an HSA or a Long-Term Care Insurance policy, you can deduct a specific amount of your premium from your taxes each year. You can do this through an HSA or by itemizing your medical expenses on your federal income taxes. 

Either way, the same deduction amounts apply. Below, we’ve created a table to demonstrate these deductions.

Total Amount That Can Be Deducted From Long-Term Care Insurance Premiums Either By Itemized Tax Deduction or Reimbursement With An HSA

Frequently Asked Questions About Health Savings Accounts

While the information above can be beneficial to some, we understand that you may still have specific questions about health savings accounts. Below, we’ve put together a list of commonly asked HSA questions and concerns. 

Are HSAs “Use It or Lose It”?

No, health savings accounts are not bound by the “use it or lose it” mentality. In fact, the only way to lose your HSA is to intentionally get rid of it or use all of the money within your account. You can think of an HSA as an IRA for health-related expenses. 

HSAs are personal accounts tied to the owner. You won’t lose your HSA if you switch jobs, move to a different state, or retire. Even if you pass away, your beneficiaries will still receive your HSA as an inheritance.  

What’s The Difference Between Health Savings Accounts & Health Reimbursement Arrangements? (HSA vs. HRA)

Another account you may confuse your HSA with is a health reimbursement arrangement (HRA). These accounts are operated and owned by employers; they’re not personalized individual accounts.

Health reimbursement arrangements are funded by employers. These accounts will help reimburse employees for the cost of medical expenses or insurance premiums. 

Unlike HSAs, health reimbursement arrangements are not savings accounts. Individuals cannot withdraw money from an HRA at will. Instead, the account is employer-controlled and can only be used for reimbursement purposes. 

HRAs are tied to the employer, meaning if the employee with an HRA were to switch workspaces, they’d lose their HRA coverage. 

Can You Use Your Health Savings Account As A Retirement Fund?

An HSA is a type of retirement/savings account. However, it shouldn't be used in place of a traditional retirement fund.

Health savings accounts only offer tax-free benefits for qualified medical expenses, which means any other expense may be subject to varying degrees of taxes. 

In conjunction with a traditional retirement account, HSA can work wonders to lower your overall medical care costs. But only having an HSA and no other retirement funds can put you in a tricky position. 

In other words, an HSA should not be your only retirement fund. However, an HSA can be beneficial as an addition to other retirement savings accounts. 

Can You Invest Your HSA Funds?

You can invest your HSA funds; however, investment choices may be more limited than traditional retirement and investing funds. Often, HSAs are eligible to invest in stocks, bonds, and mutual funds. It’s best to ask an expert what you can and can’t invest in. 

What Are HSAs & How Do They Work?

Health savings accounts (HSAs) are powerful tools for saving and planning for current and future care needs. They offer tax advantages, flexibility, and, most importantly, a safety net in times of need. 

Your HSA will stay with you as long as you choose. These accounts are portable across employers and do not expire. You can use your HSA to pay for qualified medical expenses completely tax-free. 

This can help you save money on your federal income tax and help mitigate care costs. By leveraging your HSA's tax benefits and planning resources, you can take control of your care finances for peace of mind about the future. 

If you enjoyed this article, we encourage you to read some of our other resources. At LTC News, we work hard to provide useful and accurate long-term care information. We have several other valuable articles to help you move forward in your long-term care journey. 

• How To Pay For Long-Term Care – This article explains methods to pay for long-term care, including using your HSA money to pay for long-term care-related expenses.

• Long-Term Care Tax Benefits Guide – In this guide, you can learn about anything long-term care tax-related. This includes more tax information on health savings accounts and long-term care planning resources.