Health savings account pros and cons

A health savings account (HSA) allows anyone with a qualifying 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 The funds are held by an HSA trustee (a bank, credit union or other financial institution) until it is withdrawn to pay for certain health-care expenses.

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

Basics of a health savings account

Consumers with a qualifying 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 reach age 55 by 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 paycheck, you reduce your taxable income by the amount you contribute. The interest accrued on the HSA account also isn’t taxable. With a big enough account balance, most trustees allow you to invest HSA funds in mutual funds, bonds or stocks.

Advantages of a health savings account

There are several advantages to opening a health savings account.

• Contributions are pre-tax: If you contribute to your HSA by paycheck deduction, those funds are pre-tax. Your employer, a relative or anyone else can contribute, and those funds are also tax-free.
• Withdrawals aren’t taxable:  Withdrawals aren’t taxable as long as the money is used to pay for qualifying health-care expenses.
• Federal tax deduction: You can keep contributing to an HSA if you’re not working and deduct them on your federal tax return.
• No nonmedical penalty after 65: At age 65, funds used to pay for nonmedical expenses are taxable, but there isn’t a 20 percent tax penalty.
• No opening deposit: Typically, there’s no minimum deposit required to open an HSA account.
• Balance rolls over: Unlike a flexible spending account, or FSA, which must be spent by the end of the plan year, HSA balances roll over. There’s no time limit for spending the funds.
• Investment opportunities: An HSA allows you to invest your funds in stocks, bonds and other instruments. Earnings are tax-free. Some trustees require a specific minimum balance before they allow you to invest.
• Portability: HSAs are portable. You own the account. If you leave your job, you can take the HSA with you.
• Insurance-eligible: HSAs held in federally insured banks and credit unions are insured for up to $250,000.
• Benefits to family: HSA funds can be used to pay for qualified medical expenses for your spouse and dependent children, even if they aren’t covered under your HDHP.
• Offset Medicare premiums: After retirement, funds can be used to pay for 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 for approved medical expenses as needed.

Disadvantages of a health savings account

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

• Nonmedical expense penalties: Prior to age 65, HSA funds withdrawn to pay for nonmedical expenses are considered taxable income. The IRS also levies a 20 percent penalty.
• Social Security penalties: 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’re ineligible for an HSA.
• For people enrolled in HDHPs only: Only those with high-deductible health plans qualify for an HSA. Meeting a high insurance deductible might be a hardship.
• 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.
• Weak earnings and investment limits: Interest rates on HSA accounts may be low and some trustees charge a monthly fee if your balance drops below a certain threshold. Minimum balance requirements may apply before you can invest; investment options may be limited, and investments are not insured.
• No more contributions: Once an individual reaches age 65 (the age for Medicare eligibility), additional contributions (including catch-up contributions) can no longer be made, even if still employed.

Is a HSA right for you?

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

HSAs have fewer limitations and more tax advantages than FSAs. As HSA funds roll over and continue to grow, they can benefit you in 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 great HSA providers available to consider to find the right fit for you.

— Freelance writer Ashlee Tilford contributed to updating this article. Former Bankrate writer Libby Wells wrote a previous version of this article.