Health Savings Account (HSA) Tax Considerations

By Zack Gutches, CFP®, CPA | Jan 31, 2024 |

The Health Savings Account (HSA) value proposition is pretty compelling. Contributions are tax-deductible, growth is tax-free, and — as long as they are for qualified medical expenses — withdrawals are tax-free too.  

But as persuasive as that is, there are HSA rules and regulations (specifically health savings account tax ones) you need to be aware of — and not trip over — if you want to make HSAs a valuable tool for managing healthcare expenses.  

HSA contribution limits

For 2024, the maximum contribution limit for an individual with self-only coverage is $4,150, while for those with family coverage, it is $8,300. Individuals aged 55 or older can make an additional catch-up contribution of $1,000.  (In certain situations, married couples over 55 — but not on Medicare — can both make $1,000 catch-ups.) 

Significantly, the individual who owns the account isn’t required to be enrolled in their own healthcare plan. A young adult, covered under their parents’ HDHP plan (and not classified as a dependent on their parent’s tax return), could potentially qualify to contribute to their personal HSA. 

Furthermore, to be eligible to contribute to an HSA, individuals must be covered by a high-deductible health plan (HDHP). They cannot be enrolled in Medicare or claimed as a dependent on someone else’s tax return.  

Health Savings Account tax advantages

Tax deductions for HSA contributions

Money contributed to your HSA is deducted from your taxable income—reducing your overall tax liability by lowering your taxable income and potentially moving you into a lower tax bracket.  (NOTE: California and New Jersey do not give you a state income tax deduction for HSA contributions.) 

HSA deferrals are not subject to FICA taxes. For those under the Social Security wage base ($168,600 for 2024), this means you dodge 7.65% FICA tax (6.2% SS and 1.45% Medicare) but also means those wages don’t count towards your Social Security benefit either (since you didn’t pay into the system). 

You can make current tax year contributions to your HSA until the tax filing deadline.  However, a special “last-month rule” rule allows individuals to make contributions for the previous tax year if they are eligible to contribute for the entire current tax year.  

You may not get tax deductions for HSA contributions in certain situations. Here are some scenarios to be aware of: 

  • Exceeding Contribution Limits: If you contribute more than the annual contribution limits set by the IRS, the excess contributions are not tax-deductible. It’s important to be aware of the contribution limits and stay within those limits to avoid potential tax issues. 
  • Not Eligible for an HSA: To contribute to an HSA, you must be covered by a High Deductible Health Plan (HDHP) and meet other eligibility criteria. Any contributions made may not be tax-deductible if you are not eligible for an HSA. 
  • Coverage by Other Health Plans: If you have non-HDHP coverage (such as through a spouse’s health plan) that provides disqualifying coverage, your contributions to an HSA may not be tax-deductible. 
  • Receiving Medicare Benefits: If you are enrolled in Medicare, you are generally not eligible to contribute to an HSA, and any contributions made while on Medicare may not be tax-deductible. 
  • Ineligible for “13-month rule”: If you fail to remain eligible for the HSA for the entire 13-month period, there may be tax implications, including penalties and taxes on the contributions made for the previous tax year.  

Tax-free growth of HSA funds

Any funds you contribute to your HSA can be invested, and any earnings or interest generated on those investments are tax-free and not subject to annual capital gains taxes. There are certain scenarios in which you may not have tax-free growth of HSA funds. Here are some situations to be aware of: 

  • Non-Qualified Withdrawals: If you withdraw from your HSA for non-qualified expenses before age 65, the withdrawn amount may be subject to income tax and a 20% penalty. In this case, the growth of those funds used for non-qualified expenses is not tax-free. 
  • Excess Contributions: If you contribute more than the annual limits set by the IRS, the excess contributions are subject to a 6% excise tax. Any earnings on these excess contributions will not be tax-free. 
  • Not Using the Funds for Qualified Medical Expenses: While HSAs allow tax-free growth, this applies specifically to funds used for qualified medical expenses. If you use the funds for non-qualified expenses, the growth of those funds may be subject to taxes and penalties. 
  • Losses on Investments: If the investments within your HSA incur losses, the overall growth may be negative. However, the losses themselves do not trigger taxes, and the remaining funds can continue to grow tax-free. 
  • Not Meeting HSA Eligibility Criteria: To enjoy the tax benefits of an HSA, you must be eligible by having a High Deductible Health Plan (HDHP) and meeting other criteria. If you lose HSA eligibility, the tax-free growth may be affected. 

Tax-free withdrawals for qualified medical expenses

The most important health savings account tax advantage is the ability to use the funds for qualified medical expenses on a tax-free basis. Perhaps unsurprisingly, the biggest hurdle people trip over with HSAs is making withdrawals for non-qualified medical expenses. If you do and are over age 65, withdrawals are taxed as income. Here are some situations to be aware of:   

  • Non-Qualified Expenses: If you use HSA funds for expenses that do not qualify as medical expenses under IRS guidelines, you won’t receive tax savings on those withdrawals. Non-qualified expenses may include items like cosmetic surgery, certain health supplements, or other non-prescribed medications. 
  • Withdrawals for Non-Medical Purposes: If you withdraw funds from your HSA for non-medical purposes before the age of 65, the withdrawn amount may be subject to both income tax and a 20% penalty. This applies even if the expenses are not qualified medical expenses. 
  • Using HSA Funds for Non-Eligible Individuals: HSA funds are intended for the account holder, their spouse, and eligible dependents. If you use HSA funds for the medical expenses of someone who is not an eligible individual, the expenses may not be considered qualified. 
  • Receiving Medicare Benefits: If you are enrolled in Medicare, you can no longer contribute to an HSA.  
  • Using HSA Funds for Insurance Premiums: In general, using HSA funds to pay health insurance premiums is not considered a qualified medical expense unless specific criteria are met (e.g., for certain long-term care insurance or if you are receiving federal or state unemployment benefits) 

Maximizing Health Savings Accounts contributions 

Plan your contributions based on future healthcare expenses. By estimating your healthcare needs for the upcoming year, you can determine the appropriate amount to contribute to your HSA. This proactive approach allows you to take full advantage of the tax benefits while ensuring you have enough funds to cover your medical costs. 

Consider investing your HSA funds for long-term growth. While HSAs are typically used to pay for current medical expenses, they can simply be an investment tool that potentially earn tax-free returns over time. 

Using HSA contributions effectively

When it comes to managing your Health Savings Account (HSA), understanding how to use your contributions effectively is key. By maximizing the benefits of your HSA funds (and taking into account health savings account tax considerations), you can make the most of this valuable financial tool. 

  • Keep track of your expenses and save your receipts as documentation for tax purposes. 
  • Stay within the annual contribution limits set by the IRS to avoid potential tax penalties. 
  • Roll over unused HSA funds to next year.  

Unlike Flexible Spending Accounts (FSAs), HSAs do not have a “use it or lose it” provision. This means that any funds remaining in your HSA at the end of the year will roll over and continue to grow tax-free. Rolling over unused funds allows you to build a substantial balance over time, providing even more financial security for future medical expenses. 

HSAs offer a great vehicle to save for medical expenses. Understanding the tax implications of how you leverage them will ensure you reap the maximum benefit. Consider five ways to maximize your health savings account. 

FAQ

Is it better to put money in 401k or HSA? 

If an employer offers a 401(k) match, it’s often recommended to contribute to that first. Consider personal financial goals, tax situations, and healthcare needs when deciding between the two, with many individuals finding value in contributing to both. 

HSAs are not an ideal legacy asset. If you pass away, and a non-spouse is the beneficiary on your HSA, they are required to take a full distribution of the account in that year and pay income taxes on all of it. So, while accumulating HSA funds and growing them is a good thing, there are disadvantageous tax distribution rules when passed on as part of an inheritance.   

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Whether you have a specific question, or you’re interested in learning more about how our approach can be tailored to your situation, we’d love to hear from you.