Advantages and disadvantages of health savings account

Key takeaways

• Health Savings Accounts (HSAs) have many benefits, including tax breaks, balance deferrals, portability, investment opportunities, and family sharing.

• Disadvantages of HSAs include tax penalties for non-medical expenses before age 65, and contributions made to the HSA within six months of claiming Social Security benefits may be subject to penalties.

• HSAs have fewer limitations and more tax benefits than flexible spending accounts (FSAs).

A health savings account (HSA) allows anyone with an eligible high-deductible health plan to set aside pre-tax money to pay for approved medical expenses. The funds are held by an HSA trustee (a bank, credit union, or other financial institution) until they are withdrawn to pay certain healthcare expenses.

Health savings accounts have various advantages, but also have significant disadvantages that are important to consider.

Basics of a Health Savings Account

Consumers with an eligible high-deductible health plan, or HDHP, are most likely to use a health savings account.

For 2024, the HSA contribution limit is $4,150 for an individual and $8,300 for family coverage. Employees who turn age 55 at the end of the tax year can contribute an additional $1,000 as a catch-up provision.

If your HSA contributions are deducted from your salary, you reduce your taxable income by the amount you contribute. Interest accrued on the HSA account is also not taxable. With a large enough account balance, most trustees allow you to invest HSA funds in mutual funds, bonds, or stocks.

Benefits of a health savings account

Opening a health savings account has several advantages.

• Contributions are before taxes: If you contribute to your HSA through payroll deduction, these funds are pre-tax. Your employer, a loved one or anyone else can contribute, and these funds are also tax-free.

• Withdrawals are not taxable: Withdrawals are not taxable as long as the money is used to pay for qualified healthcare expenses.

• Federal tax deduction: You can continue to contribute to an HSA if you’re not working and deduct them on your federal tax return.

• No non-medical sanction after 65 years: At age 65, funds used to pay for non-medical expenses are taxable, but there is no 20 percent tax penalty.

• No opening deposit: Generally, no minimum deposit is required to open an HSA account.

• The balance is renewed: Unlike a flexible spending account, or FSA, which must be spent before the end of the plan year, HSA balances roll over. There is no time limit for spending the funds.

• Investment opportunities: An HSA allows you to invest your funds in stocks, bonds, and other instruments. Income is exempt from tax. Some trustees require a specific minimum balance before allowing you to invest.

• Portability: HSAs are portable. You own the account. If you leave your job, you can take the HSA with you.

• Eligible for insurance: HSAs held at federally insured banks and credit unions are insured up to $250,000.

• Benefits for the family: HSA funds can be used to pay for qualified medical expenses for your spouse and dependent children, even if they are not covered by your HDHP.

• Compensation for Medicare premiums: After retirement, funds can be used to pay Medicare or Medicare Advantage plan premiums (but not Medigap policies).

• Easy transfers: HSA funds invested in mutual funds or stocks can be transferred to pay approved medical expenses as needed.

Disadvantages of a health savings account

It’s important to consider the potential downsides of using a health savings account.

• Penalties for non-medical expenses: Before age 65, HSA funds withdrawn to pay for non-medical expenses are considered taxable income. The IRS also imposes a 20 percent penalty.

• Social Security Sanctions: If you don’t stop contributing to your HSA six months before you apply for Social Security benefits, tax penalties may apply.

• Not everyone is eligible: If you are claimed as a dependent on someone else’s tax return, you are not eligible for an HSA.

• For people registered with HDHP only: Only people with high-deductible health plans are eligible for an HSA. Meeting a high insurance deductible can be difficult.

• Rejection of HSA cards: Not all stores accept HSA debit cards, so you may have to pay for your expenses out of pocket and get reimbursed by your HSA trustee.

• Low income and investment limits: Interest rates on HSA accounts can be low, and some administrators charge a monthly fee if your balance falls below a certain threshold. Minimum balance requirements may apply before you can invest; investment options may be limited and investments are not insured.

• More contributions: Once an individual reaches age 65 (the Medicare eligibility age), additional contributions (including catch-up contributions) can no longer be made, even if they are still employed.

Is an HSA right for you?

Savers who want to put money aside for healthcare costs may have access to an HSA or an FSA – or possibly both, depending on the employer’s benefits plan. Both offer tax benefits, so compare the two accounts before making a choice.

HSAs have fewer limitations and more tax benefits than FSAs. As HSA funds grow and continue to grow, they can benefit you during your golden years, when many seniors worry about incurring medical expenses that aren’t covered by insurance. If your employer doesn’t offer an HSA or you want to pursue your own options, there are many excellent HSA providers to consider to find the solution that’s right for you.

— Freelance writer Ashlee Tilford contributed to updating this article. Former Bankrate editor Libby Wells wrote an earlier version of this piece. article.