Health Savings Accounts (HSAs): What You Need to Know

Jason Branning

What’s the most tax-friendly financial account out there?

Is it the IRA? The 401(k)? Or maybe the good old taxable account? Each of these have their advantages, but Health Savings Accounts (HSAs) might take the prize! 

You may have heard that HSAs offer a triple tax advantage. But what does that really mean?

  • Tax-Deductible Contributions – The money you contribute to an HSA is tax-deductible, which lowers your taxable income for the year, similar to a traditional 401(k) contribution. Additionally, if you contribute via payroll deductions, they’re exempt from FICA taxes (Social Security and Medicare).
  • Tax-free growth – Any money in your HSA grows tax-free, meaning you won’t pay taxes on interest, dividends, or investment gains within the account.
  • Tax-free withdrawals (for qualified medical expenses) – When you use HSA funds for eligible medical expenses, you do not pay any taxes on withdrawals, making it a powerful tool for covering healthcare costs. 

How To Effectively Use HSAs

1. Treat It Like a Retirement Investment Account (My Favorite Option)

Instead of using your HSA funds immediately for medical expenses, consider investing them to grow tax-free over time.

Most HSAs allow you to invest in mutual funds, ETFs, or stocks and bonds, similar to a 401(k) or IRA.

Once you turn 65, you can withdraw funds for any purpose without facing a penalty. Just remember that non-medical withdrawals will be taxed at your ordinary income rate.

2. Use It for Tax-Free Medical Expenses

Pay for qualified medical expenses like prescriptions, doctor visits, and dental work without dipping into your taxable income.

Be sure to keep receipts for medical expenses you pay out-of-pocket (digitally if you can!). One big advantage of HSAs is that you can reimburse yourself tax-free, even years later. Since healthcare costs often increase in retirement, this strategy can be especially beneficial. 

3. Use It as a Backup Emergency Fund

Since there’s no deadline to reimburse yourself for past medical expenses, you can let your HSA grow while saving medical receipts.

If you ever need cash, you can withdraw funds for past expenses tax-free, making it a variable backup emergency fund. 

Things to Remember Before Opening an HSA

Before you open an HSA, there are a few important points to consider:

  • Check Your Eligibility – To qualify for an HSA, you have to be enrolled in a High Deductible Health Plan (HDHP). For 2025, this means your plan must have a minimum annual deductible of $1,650 for individual coverage or $3,300 for family coverage. You cannot be enrolled in Medicare, have a Flexible Spending Account (FSA), or be claimed as a dependent on someone else’s tax return.
  • Contribution Limits – For 2025, the HSA contribution limit is $4,300 for individuals and $8,550 for families. If you’re 55 or older, you can contribute an additional $1,000 annually, which is a “catch-up” contribution. 
  • Not All HSAs Are the Same – Some HSA providers charge maintenance fees or transaction fees, which can eat into your savings/investments. Look for low-fee providers with robust investment options. 

Surely There Is A Catch?

There’s no such thing as the “perfect account.” Here are a few potential drawbacks of HSAs:

  • HDHP Requirement – To open an HSA, you must be enrolled in a High Deductible Health Plan. While these plans can save you money on premiums, they also come with high deductibles. If you have frequent medical needs or prefer lower out-of-pocket costs, an HDHP might not be the best fit, especially in the short term.
  • Upfront Medical Costs – With an HDHP, you may need to pay higher out-of-pocket costs before insurance coverage kicks in. This could mean paying for a significant portion of your healthcare expenses (prescriptions, medical services, etc.) out-of-pocket, which may not be ideal if you have ongoing health issues or need frequent medical care.
  • Record-Keeping Burden – You must track receipts and ensure that expenses are qualified to avoid tax penalties or potential audits.
  • Withdrawals Before 65 – If you withdraw funds from your HSA before age 65 for anything other than qualified medical expenses, not only will you face a 20% penalty, but you will also be taxed at your ordinary income rate. This penalty is one of the most severe in the tax code for early withdrawals, so be sure that you are using the funds as intended. 

There’s not another account out there like the HSA. For those who qualify, its advantages can far outweigh potential drawbacks. When used properly, an HSA can be a powerful tool for building wealth. Check today to see if an HSA is the right fit for your financial plan.

Johnson is a fee-only, fiduciary financial advisor with Asset Dedication LLC, DBA Branning Wealth Management. He provides hands-on, practical financial advice for millennials and young families. He is a board member of the Financial Planning Association of Mississippi. 

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