Health savings account

Based on Wikipedia: Health savings account

The Tax Shelter Hiding in Plain Sight

There's a financial account that lets you contribute money tax-free, grow it tax-free, and withdraw it tax-free. It's not a Roth IRA with its income limits, not a 401(k) with its withdrawal penalties, and not some offshore scheme that will land you in trouble with the Internal Revenue Service. It's called a Health Savings Account, or HSA, and roughly 40 million Americans have one—though many of them don't fully understand what they're holding.

Here's the remarkable thing: the HSA is the only account in the American tax code that offers this triple tax advantage. Money goes in before taxes. It grows without being taxed. And when you pull it out for medical expenses, no tax then either. Financial planners sometimes call it the "stealth IRA" because in the right hands, it becomes one of the most powerful retirement tools available.

But there's a catch. You can't just open one whenever you want.

The Gatekeepers: High-Deductible Health Plans

To qualify for an HSA, you must be enrolled in what the government calls a High-Deductible Health Plan, commonly abbreviated as HDHP. This isn't just marketing language—the IRS has specific thresholds that define what counts as "high deductible."

The logic is simple, if a bit paternalistic. The government figured that if you're taking on more financial risk with your health insurance (accepting a higher deductible means paying more out-of-pocket before coverage kicks in), you should get a tax break to help you save for those expenses. The HSA was designed as that safety net.

There are other rules too. You can't be enrolled in Medicare. You can't be claimed as a dependent on someone else's taxes. And you can't have other health coverage that might undermine the high-deductible arrangement. The government wanted this to be an all-or-nothing commitment.

How HSAs Differ from Their Cousins

The alphabet soup of health-related accounts confuses almost everyone. Let's untangle it.

A Flexible Spending Account, or FSA, is the use-it-or-lose-it account many employers offer. You put money in pre-tax, but if you don't spend it by year's end (or shortly after, depending on your plan's grace period), it vanishes. Gone. Back to your employer. This creates the bizarre December ritual of people desperately buying glasses they don't need or stockpiling bandages.

An HSA is the opposite. Your money stays yours forever. It rolls over from year to year, decade to decade. You could contribute throughout your working life, never touch it, and use it all when you're 80. This fundamentally changes the psychology of the account—it becomes an investment vehicle, not just a spending account.

Then there's the Health Reimbursement Arrangement, or HRA. This one's entirely funded and owned by your employer. They put money in, they control the rules, and if you leave the company, the money typically doesn't follow you. It's a benefit, not an asset you own.

The HSA stands apart because it belongs to you. Your employer can contribute to it, and many do, but it's your account. Change jobs? Take it with you. Retire? It's still yours. Die? It can pass to your spouse tax-free, or to other beneficiaries as taxable income.

The Birth of an Idea

HSAs didn't exist before 2004. They were created by the Medicare Prescription Drug, Improvement, and Modernization Act, signed by President George W. Bush on December 8, 2003. The law took effect for tax years beginning after that year.

The accounts replaced an earlier experiment called Medical Savings Accounts, which had similar goals but more restrictions. Congress had been testing the concept with limited pilot programs, and the HSA represented the full rollout.

The political philosophy behind HSAs comes from a school of thought called consumer-driven healthcare. The idea is that when people spend their own money on healthcare—rather than just paying a flat copay regardless of the actual cost—they become more careful consumers. They shop around. They question whether they really need that MRI. They choose generic drugs over brand names.

Critics argue this theory works better on paper than in emergency rooms. When you're having chest pains, you're not comparison shopping hospitals. And the complexity of medical billing makes informed consumerism nearly impossible even when you're not in crisis. There's also the uncomfortable reality that the people who benefit most from HSAs tend to be healthy and wealthy—those who can afford to leave money untouched for years while it grows.

The Numbers Tell a Story

When HSAs first launched, adoption was slow. By January 2007, only about 4.5 million Americans had HSA-qualified health plans. That included 3.4 million through employers and 1.1 million who bought individual policies.

But the trajectory was upward. By 2008, it was 6.1 million. By 2012, it had more than doubled to 13.5 million. And by June 2025, according to research by the investment firm Devenir, an estimated 40 million Health Savings Accounts held approximately $159 billion.

That's a lot of money sitting in accounts that many holders don't fully understand or optimize.

A fascinating detail emerged from a 2008 Government Accountability Office report. They found that 42 to 49 percent of people enrolled in HSA-eligible health plans never actually opened an HSA. They had the qualifying insurance but never took the step of creating the account that would let them capture the tax benefits. It's like having a key but never bothering to see what door it opens.

The report also revealed something about who uses these accounts. Tax filers who reported HSA activity had higher average incomes than other filers. They contributed about twice as much as they withdrew—$2,100 in versus $1,000 out, on average. Nearly half of contributors made no withdrawals at all in a given year.

This pattern suggests that many HSA holders are using the accounts not as spending vehicles but as investment accounts, letting the money accumulate for future use.

The Contribution Limits and the Catch-Up Game

Congress sets annual limits on how much you can contribute to an HSA. For 2021, the limit was $3,600 for individuals with self-only coverage or $7,200 for those with family coverage. These numbers adjust for inflation each year.

There's also a catch-up provision for people aged 55 and older. They can contribute an extra $1,000 per year beyond the standard limit. This catch-up amount started at $500 when HSAs launched and increased by $100 annually until it capped at $1,000 in 2009.

Unlike some retirement accounts, HSA contributions can come from anyone—you, your employer, a family member, or any other person. When employers contribute, they must follow non-discrimination rules to ensure they're treating employees fairly, though they can differentiate between full-time and part-time workers or between those with individual versus family coverage.

Here's a strategic detail: if your employer offers payroll deductions for HSA contributions, that money avoids both income tax and Federal Insurance Contributions Act (FICA) taxes—the payroll taxes that fund Social Security and Medicare. If you contribute on your own, outside of payroll, you get the income tax deduction but still pay FICA taxes on that money. The difference might seem small, but for high contributors over many years, it adds up.

What Counts as a Qualified Expense

The list of what you can pay for with HSA funds is surprisingly broad. Obviously, it includes things your health insurance doesn't fully cover—deductibles, coinsurance, and copayments. But it extends well beyond that.

Dental care? Covered. Vision care? Covered. Chiropractic adjustments, hearing aids, eyeglasses, even transportation to medical appointments—all qualified expenses. The IRS publishes detailed guidance on what counts, and it's more generous than most people realize.

Over-the-counter medications had an interesting journey. Originally, you could buy aspirin and cold medicine with HSA funds. Then the Patient Protection and Affordable Care Act (often called Obamacare) changed the rules in 2011, requiring a doctor's prescription for over-the-counter drugs to qualify. This created an absurd situation where you needed to visit a doctor to get permission to buy something available without a prescription at any pharmacy.

The COVID-19 pandemic brought another reversal. The CARES Act of 2020 restored the ability to use HSA funds for over-the-counter medications without a prescription. It also, for the first time, explicitly recognized menstrual care products as qualified medical expenses.

What's generally not covered? Health insurance premiums, with some exceptions. You can use HSA funds for COBRA continuation coverage premiums when you're between jobs, for health insurance premiums while receiving unemployment benefits, and for certain Medicare expenses. Long-term care insurance premiums also qualify, up to limits that increase with age.

The Investment Angle

This is where HSAs get interesting for long-term planning.

Funds in an HSA can be invested, much like money in a 401(k) or IRA. Most HSA custodians offer options like money market funds, certificates of deposit, stocks, bonds, and mutual funds. Some even allow alternative investments like real estate or precious metals, though the same prohibited investments that apply to IRAs also apply to HSAs—no life insurance policies, no collectibles.

The investment earnings grow tax-free as long as they stay in the account. When you eventually withdraw for qualified medical expenses, even the gains aren't taxed. This is the triple tax advantage in action: tax-free going in, tax-free while growing, tax-free coming out.

There's a strategic approach some financial planners recommend for those who can afford it: pay current medical expenses out of pocket, let your HSA investments grow for decades, keep your medical receipts, and then reimburse yourself in retirement. There's no time limit on reimbursement—you just need to be able to document that the expense was incurred after you opened the HSA.

A person could theoretically incur $50,000 in medical expenses over their working life, pay for all of it from their regular bank account, let their HSA grow to several hundred thousand dollars through compounded investment returns, and then take a completely tax-free distribution by presenting those old receipts. It's perfectly legal, though it requires discipline and record-keeping.

The Retirement Connection

Here's something that surprises many people: after age 65, HSA funds can be used for anything, not just medical expenses.

If you withdraw money for non-medical purposes before 65, you face a 20 percent penalty plus ordinary income tax—a steep price that makes such withdrawals almost never worthwhile. But after 65, that penalty disappears. You still pay ordinary income tax on non-medical withdrawals, which puts the account on par with a traditional IRA for retirement income purposes.

This creates an interesting planning opportunity. You can treat your HSA as a supplemental retirement account that offers better-than-IRA treatment for medical expenses (tax-free versus just tax-deferred) and equivalent treatment for everything else after 65. Given that healthcare costs often surge in retirement, having a dedicated tax-advantaged account for those expenses is genuinely valuable.

Unlike a 401(k) or traditional IRA, HSAs have no required minimum distributions. You're never forced to take money out at a certain age. This means the account can continue growing indefinitely, potentially becoming a legacy asset or a reserve for late-in-life medical needs.

The State Tax Wrinkle

While HSAs offer federal tax advantages, state treatment varies—and this catches some people off guard.

Most states follow the federal treatment and don't tax HSA contributions, growth, or qualified withdrawals. But California and New Jersey do not recognize the HSA's tax-advantaged status at all. Residents of those states pay state income tax on contributions, on interest earned, and on capital gains within the account.

New Hampshire and Tennessee don't have a general income tax, but they do tax dividends and interest—including HSA earnings. This means even in states without broad income taxes, HSA investment income might face state taxation.

If you live in one of these states or are considering moving to one, the HSA's value proposition changes. The federal benefits remain, but the triple tax advantage becomes only a double or single advantage for state purposes.

The One-Time IRA Rollover

Congress added an unusual provision in 2006 that allows a one-time transfer from a traditional or Roth IRA into an HSA. The amount transferred counts against your annual HSA contribution limit for that year.

Why would anyone do this? There are a few scenarios where it makes sense. If you suddenly qualify for an HSA late in the year and want to maximize contributions, an IRA rollover can help. If you have an old traditional IRA with a low balance and want to simplify your accounts while gaining the HSA's superior tax treatment for medical expenses, it might be worthwhile. Or if you anticipate significant near-term medical expenses and want to pay them from tax-advantaged money you already have, this provides an avenue.

But you only get to do this once in your lifetime, so it's worth careful consideration before pulling that trigger.

Who Wins and Who Loses

HSAs work brilliantly for certain people. If you're generally healthy, have enough income to leave contributions untouched for years, and are comfortable with a high-deductible health plan, the account becomes a powerful wealth-building tool. You're essentially being paid, through tax advantages, to save money you might never need to spend on healthcare.

For others, the structure is less favorable. If you're living paycheck to paycheck and can't afford to leave money in an account when you have immediate expenses, the investment benefits are theoretical at best. If you have chronic health conditions that require frequent care, a high-deductible plan might cost you more overall than a traditional plan with higher premiums but lower out-of-pocket costs. The math is complicated and personal.

Critics of HSAs point to this as a regressive feature of the system. The tax benefits are worth more to people in higher tax brackets. A deduction is worth 37 cents per dollar to someone in the top bracket but only 12 cents to someone in the lowest. And the people who can afford to invest HSA funds and let them grow for decades are generally those who least need help affording healthcare.

Proponents counter that the accounts make healthcare costs more visible and give people more control over their medical decisions. Without an insurance company gatekeeping every choice, patients can decide for themselves what care is worth pursuing. And the long-term savings incentive encourages people to plan for future healthcare needs rather than assuming the system will take care of them.

The Affordable Care Act Connection

Some observers noticed that HSA enrollment accelerated after the Affordable Care Act took full effect. This might seem paradoxical—a tool associated with conservative healthcare philosophy thriving under liberal healthcare reform—but there's a logical explanation.

The ACA required all employers with 50 or more employees to offer health insurance. This brought many employers into the health insurance market for the first time, and they often looked for the most affordable options. High-deductible health plans typically have lower premiums than traditional plans, making them attractive for both cost-conscious employers and employees who want to minimize their paycheck deductions.

Since you need a high-deductible plan to qualify for an HSA, this created more opportunities for HSA enrollment. The mandate that seemed like it might threaten consumer-driven healthcare actually provided it with a larger addressable market.

Looking Forward

With $159 billion sitting in 40 million accounts as of mid-2025, HSAs have become a significant feature of the American financial landscape. They've grown from a policy experiment into an established part of how many Americans save for healthcare and retirement.

The accounts sit at the intersection of several ongoing debates: about how to control healthcare costs, about who benefits from tax advantages, about individual responsibility versus collective provision, about whether consumers can effectively shop for healthcare the way they shop for other goods and services.

For individuals, the practical question is simpler: if you have access to an HSA, are you using it optimally? Many people contribute just enough to cover expected medical expenses, missing the investment opportunity. Others don't open accounts at all, leaving federal tax benefits on the table. And some don't understand the rules well enough to avoid the pitfalls, like using funds for non-qualified expenses and facing taxes plus penalties.

The HSA is one of those rare financial tools that rewards both careful study and patient execution. Those who understand it fully and use it strategically can capture benefits worth tens of thousands of dollars over a lifetime. Those who ignore it or misuse it get none of that advantage.

In a financial system full of complexity, the HSA stands out as something worth understanding—a genuine opportunity hiding in plain sight within the tax code.