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What is an HSA, and how does it work?

Key takeaways

  • A health savings account (HSA) is a tax-advantaged way to save for qualified medical expenses.
  • HSAs pair with an HSA-eligible health plan.
  • Because it offers potential tax advantages and money within the account can be invested, an HSA can be used to pay for both near-term medical expenses and expenses in retirement.

A health savings account (HSA) has potential financial benefits for now and later. Not only can you save pre-tax dollars in this account to pay for qualified medical expenses, but HSAs can also provide valuable retirement benefits.

Here's how to take full advantage of HSAs.

What is an HSA?

An HSA is a tax-advantaged account that can be used to pay for qualified medical expenses, including copays, prescriptions, dental care, contacts and eyeglasses, bandages, X-rays, and a lot more. It’s "tax-advantaged" because your contributions reduce your taxable income, and the money isn't taxed while it’s in the account—even if it earns interest or investment returns. Bonus: As long as you use your HSA funds for qualified medical expenses, you won't owe taxes when you take money out of the account. These 3 reasons are why HSAs are considered "triple" tax advantaged.1 This means they provide more tax advantages than retirement accounts, such as 401(k)s or individual retirement accounts (IRAs).

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How does an HSA work?

HSAs work together with an HSA-eligible health plan. If you're enrolled in this type of health plan, you can make pre-tax contributions to an HSA, allowing you to pay for qualified medical expenses tax-free. This can help create a cash cushion to offset the higher deductibles that HSA-eligible health plans typically have.

What is an HSA?

If you don't need the money in your HSA for immediate medical expenses, you can save and invest it until you do. This sets HSAs apart from another popular account, the health care flexible spending account (FSA). Unlike an HSA, money held in a health care FSA typically must be spent by the end of the plan year in which it's contributed, can't be invested, and can't be carried with you when you leave an employer.

Who can contribute to an HSA?

Not everyone is eligible to contribute to an HSA, even if they are enrolled in an HSA-eligible health plan. You can contribute to an HSA only if:

  • You aren't enrolled in a health plan sponsored by your spouse or parent that is not an HSA-eligible health plan.
  • You're not enrolled in Medicare.
  • You can't be claimed as a dependent on someone else's tax return.

Read more: 6 benefits of an HSA in your 20s and 30s

More on HSA benefits

Here's more about what you need to know about the financial advantages of HSAs.

You can deduct your contributions from your taxes HSA contributions are typically made with pre-tax income from your paychecks, similar to the way 401(k) contributions are set up. If you fund your HSA with after-tax dollars instead, you may be able to take a tax deduction on your personal taxes when you file.

HSA tax deductions can have powerful benefits: For instance, someone in the 22% federal income tax bracket could potentially save nearly 30% in taxes (federal income + FICA + potentially state income) on every dollar contributed to the HSA. That helps increase the amount of money you have for medical spending. But it's important to keep in mind, contributing via payroll deductions will lead to the most tax savings. Only contributions made with payroll deduction avoid Medicare and Social Security taxes.

Your employer may make contributions to your HSA Almost 80% of employers help employees pay for medical expenses through contributions to their HSAs.2 Think of it as a 401(k) match for your health. You won't get a tax deduction on what your employer contributes, but you will get extra money that has the potential to grow over time if invested.

You can invest funds held in your HSA By investing at least a portion of your HSA funds, you can potentially build up your medical spending nest egg, which can be especially valuable later in life. According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2023 may need approximately $315,000 saved (after-tax) to cover health care expenses in retirement.3

HSAs are not subject to "use-it-or-lose-it" rules This means you don't forfeit any money you don't use in a given year, and you can carry it forward until you reach a time that you want or need to use the money in your HSA. Combined with the ability to invest funds, this allows your health savings to benefit from compounding returns. Over 30 years of contributing and investing the 2023 HSA family maximum contribution, you could end up with over $650,000, assuming a 6% rate of return.4

Your HSA is your account, not your employer's Unlike health care FSAs, which your employer technically owns, your HSA belongs to you. So when you leave a job, you keep all of the money you've saved up in your HSA and can transfer into a new HSA or employer-sponsored HSA at your next job. You can even open an HSA if you're in an HSA-eligible health plan and your employer does not provide one—or if they do but you prefer a third-party option. It's also possible to have multiple HSAs. Some people have one for investing and another for cash to pay medical expenses. 

You can still have an FSA to address certain immediate qualified medical expenses People often think the issue of FSA vs. HSA is either/or. The truth: HSA holders can have a limited-purpose FSA to pay for qualified expenses associated with dental and vision care. That can help you have the best of both worlds: using an HSA to save for future medical expenses while you finance some current ones with an FSA. You can only open a limited-purpose FSA if your employer allows for it, however.

Starting at age 65, there is no penalty if you use HSA money for non-qualified medical expenses You will have to pay income tax, though, similar to making withdrawals from other retirement savings vehicles, like traditional 401(k)s or IRAs. It's important to note that before you turn 65, you'll face a 20% penalty—plus any applicable taxes—on withdrawals not used for qualified medical expenses.

HSAs are not subject to required minimum distributions (RMDs) Unlike 401(k)s and traditional IRAs, which require you start minimum withdrawals called RMDs when you turn 73,5 you'll never be required to take any funds out of your HSA. This can provide versatility in retirement income planning.

HSA contribution limits

Contributing to your HSA early and often and investing those savings can help you better afford medical care later. The contribution limit for 2023 is $3,850 for individual coverage and $7,750 for family coverage.

You and your employer may both contribute to your HSA, though the contribution limit remains the same, regardless of how much your employer puts in. For example, if your employer deposits $1,000 into your HSA, then you'd only be able to contribute $2,850 if you are enrolled in individual coverage in 2023.

In addition, depending on when you enroll in an HSA-eligible health plan and how long you stay enrolled, your total contribution limit may be reduced. Also you typically have until the federal tax filing deadline (usually April 15) to contribute to an HSA for the prior tax year.

How to open an HSA

Step 1: Make sure you're eligible to open an HSA To open and contribute to an HSA, you'll need to be enrolled in an HSA-eligible health plan. This health plan does not have to be provided by your employer, but it must meet the requirements outlined above. If you aren't sure whether your plan qualifies, check with your benefits administrator or plan provider.

Step 2: Pick an HSA provider While HSAs are all similar in the tax advantages they offer, the specific features available at different providers vary. If you're interested in investing your HSA, for instance, you may want to go with a provider that requires no—or a low—amount of your HSA to remain uninvested in cash. You may want to research if potential HSA providers offer low-cost funds or automated investing options, like robo-advisors, that meet your needs. You may also want to compare fees across different providers. Remember, too, you can have the flexibility to change your HSA provider even if you're no longer covered by an HSA-eligible health plan. 

Step 3: Don't forget to invest your HSA If you intend to use your HSA to save for long-term medical expenses, don't forget to set up your investments. Nearly 80% of participants do not invest their HSA assets,6 suggesting the vast majority of Americans aren't using this valuable wealth-building tool as well as they could.

Read more: How to invest your HSA

Consider a health savings account (HSA)

With an HSA, you can pay for qualified medical expenses in a tax-advantaged way.

More to explore

1. With respect to federal taxation only. Contributions, investment earnings, and distributions may or may not be subject to state taxation. Please consult with your tax advisor regarding your specific situation. 2. "2022 Health Savings Account Survey," Plan Sponsor Council of America, October 25, 2022 3. Estimate based on a single person retiring in 2023, 65-years-old, with life expectancies that align with Society of Actuaries' RP-2014 Healthy Annuitant rates projected with Mortality Improvements Scale MP-2020 as of 2022. Actual assets needed may be more or less depending on actual health status, area of residence, and longevity. Estimate is net of taxes. The Fidelity Retiree Health Care Cost Estimate assumes individuals do not have employer-provided retiree health care coverage, but do qualify for the federal government’s insurance program, original Medicare. The calculation takes into account Medicare Part B base premiums and cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by original Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services, and long-term care. 4. This calculation assumes you begin your contributions at the age of 30 and annually contribute up to the 2023 HSA contribution limit for family coverage of $7,750 over the entire period. This example also assumes a 6% rate of return, the absence of withdrawals over this 30-year period, and annual HSA catch-up contributions of an additional $1,000 starting at the age of 55 until the end of the 30-year time horizon. 5. The change in the RMDs age requirement from 72 to 73 applies only to individuals who turn 73 on or after January 1, 2023. After you reach age 73, the IRS generally requires you to withdraw an RMD annually from your tax-advantaged retirement accounts (excluding Roth IRAs, and Roth accounts in employer retirement plans accounts after December 31, 2023). Please speak with your tax advisor regarding the impact of this change on future RMDs. 6. Plan Sponsor, October 25, 2022

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

Recently enacted legislation made a number of changes to the rules regarding defined contribution, defined benefit, and/or individual retirement plans and 529 plans. Information herein may refer to or be based on certain rules in effect prior to this legislation and current rules may differ. As always, before making any decisions about your retirement planning or withdrawals, you should consult with your personal tax advisor.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.

The information provided herein is general in nature. It is not intended, nor should it be construed, as legal or tax advice. Because the administration of an HSA is a taxpayer responsibility, you are strongly encouraged to consult your tax advisor before opening an HSA. You are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS website at IRS.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses, online, or you can call the IRS to request a copy of each at 800-829-3676.

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