Health Savings Account (HSA)
Summary Definition: A specialized savings account that allows the owner to set aside and use pre-tax income for qualified medical expenses.
What is a Health Savings Account?
A health savings account (HSA) is a financial tool that allows individuals enrolled in a high deductible health plan (HDHP) to set aside pre-tax income for eligible expenses, such as medical co-payments, dental services, or drug prescriptions.
Both employees and employers may contribute to the account, but only up to the annual limit for that year. Employees can, however, further grow the account by both rolling over unused funds from one year to the next and investing any funds in other financial tools, such as stocks or bonds. Regardless, employees may continue to access and use the funds even after their employment ends.
Key Takeaways
- Health savings accounts allow individuals to save pre-tax income for eligible healthcare costs, such as medical and dental expenses or vision services.
- HSAs differ from flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs) in several ways, such as following employees even after their job ends and allowing deposited funds to earn interest or be invested.
- Despite the IRS’ annual contribution limits and potential penalties, HSAs provide significant tax benefits for employees, such as reducing the overall income tax they owe each pay period.
HSA vs. FSA
Another financial tool employers sometimes provide employees is a flexible spending account (FSA). While FSAs and HSAs are both tools for setting aside pre-tax dollars to cover healthcare expenses, they have important distinctions in how they work and who can use them.
For example, HSAs only allow access to already deposited funds, while FSAs allow immediate access to all funds for the year, even before contributions occur. FSAs also don’t allow employees to invest or earn interest on deposited amounts, nor do they require employees to enroll in an HDHP first.
In short, FSAs have fewer eligibility requirements and allow earlier access to funds but are less flexible for employees and provide few long-term savings advantages.
HRA vs. HSA
A common third option employers sometimes offer is a health reimbursement arrangement (HRA). Instead of a savings account that stores contributions for future expenses, HRAs are employer-funded plans from which employees request tax-free repayments after an eligible expense occurs.
The most significant appeal of an HRA is how flexible and customizable it can be for employers. Some plans, for example, can cover monthly health insurance plan premiums, which generally isn’t allowed under traditional HSAs and FSAs. Additionally, employers may allow and limit HRA rollover amounts.
| HSA | FSA | HRA | |
| Account Owner | Employee | Employer | Employer |
| Employee Eligibility | HDHP required | All employees | All employees |
| Annual Rollover | Yes | No* | Possibly |
| Account Portability | Follows employee | Stays with employer | Stays with employer |
| Non-Qualified Withdrawals Allowed | Yes** | No | N/A |
| Investable Funds | Yes | No | No |
| Funds Earn Interest | Yes | No | No |
*Employers can allow limited rollovers or a “grace period” to spend remaining funds, but this isn’t required.
**Such withdrawals are subject to income taxes and penalties.
How Does an HSA Work?
Eligible employees who open an HSA must first decide how much of their gross pay to deposit each pay period. Recurring contributions are usually set up as a voluntary payroll deduction, and employees can adjust this amount later if necessary.
Employers can also contribute to an HSA similar to how they match an employee’s 401(k) contributions. Employer contributions, though, don’t have to be as consistent as employee contributions and sometimes occur in larger lump sums at the beginning of the year.
Depending on the HSA provider an employer partners with, participating employees can next decide how much of the account’s funds they want to keep available in cash and how much they want to invest in stocks, bonds, mutual funds, etc. The account can then allocate future contributions to maintain that cash limit while further funding HSA investments.
Finally, participants often receive an HSA card that functions like a debit card but only for HSA-eligible expenses, such as medical care and dental services. Eligible items include prescription medications, hearing aids, contact lenses, and annual flu shots.
HSA Contribution Limits 2025
No matter how often deposits occur or where they come from, the Internal Revenue Service (IRS) sets HSA contribution limits annually. These limits are updated every April and vary depending on whether the employee enrolled in single-only or family coverage for their medical insurance.
The 2024 HSA contribution limits were $4,150 for single-only coverage and $8,300 for family coverage, while the 2025 HSA contribution limits are $4,300 and $8,550, respectively. Employees, therefore, have until April 2025 to maximize their 2025 contributions. One significant exception is for employees over 55, who can make additional “catch-up” contributions of up to $1,000 each year.
Contribution Limit Examples
- If an employee is enrolled in family coverage and contributes $6,000 before April 2025, their employer can only contribute up to $2,550 before the account hits the 2025 limit.
- Conversely, if an employee with single-only coverage contributes $2,500 during that same time, their employer can only contribute up to $1,800.
- If either employee is 55 or older, they can also make up to $1,000 in “catch-up” contributions.
HSA Tax Benefits
Health savings accounts are sometimes labeled as triple tax-advantaged accounts because of the following:
- Contributions reduce how much an employee must pay in income taxes each pay period.
- Income taxes aren’t applied to contributed amounts (including employer contributions) while they’re in the account or account growth from earned interest or investment returns.
- Amounts withdrawn for eligible expenses also aren’t subject to income taxes.
These tax advantages make HSAs more suitable for long-term savings plans and goals than FSAs or HRAs.
HSA Tax Form and Penalties
HSA rules state that when filing annual tax returns, individuals must also report all their contributions for the year on Form 8889. Employers who made additional contributions will similarly report those amounts on Form 5498-SA and provide a copy to the affected employee.
Failure to abide by health savings account rules can be costly. Withdrawals for ineligible expenses, for example, will incur standard income taxes on the withdrawn amount and a possible 20% penalty if the account owner is under 65.
Furthermore, if an employee exceeds their HSA contribution limit, they’ll have to pay a 6% excise tax for each year the excess amount remains on the account.
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