How to Best Use Your Health Savings Account

Since 2004, individuals enrolled in high-deductible health plans (HDHPs) have been able to fund health savings accounts (HSAs). A Mercer survey showed that over 80% of large employers nationally offered HSA-eligible health plans in 2022.¹ As more employers offer these plans, HSA usage has grown steadily to approximately 36 million accounts and $116 billion in assets.² We expect that HSAs will be a growing part of the health care landscape.

In an HDHP, the insured is responsible for a significant portion of health expenses up front before the insurance company pays. However, HDHPs must also include a limit on participants’ out-of-pocket expenses. Premiums on these plans are generally lower than more traditional, lower-deductible policies. See Figure 1 for current IRS parameters on HDHPs and HSAs.

The HSA is structured with significant tax incentives to choose an HDHP and save or invest for health costs. Proponents of HSAs often refer to a "triple-tax benefit": tax deduction, tax-deferred growth, and tax-free qualified distributions. This essentially combines the benefits of Roth and pretax strategies in an individual retirement account (IRA). In addition, the funds can be used before retirement for qualified medical expenses—without tax or penalty. If used before age 65 for other purposes, however, a 20% penalty is assessed. Figure 2 (in the "Full Article (PDF)" below) compares HSAs with other tax-advantaged savings vehicles.

A key consideration in the evaluation of HSAs is the definition of a “qualified medical expense.” In general, expenses that would qualify for a federal income tax deduction are considered qualified. (As you might expect, you can’t double-dip and count them both as qualified for your HSA and as itemized deductions.) Some insurance premiums are qualified: Medicare, long-term care, COBRA, and coverage while you’re unemployed. However, one significant medical premium is not qualified: Medicare supplement insurance, also referred to as Medigap. Hybrid life insurance/long-term care policies are usually considered life insurance and, therefore, aren’t qualified.

A helpful feature of HSAs is that qualified medical expenses from prior years can be used to take qualified distributions. The expenses need to have occurred after you established the HSA and cannot have been otherwise reimbursed or used for itemized deductions.⁴ This feature adds to the flexibility of HSAs if you can keep good documentation of medical expenses and tax returns (potentially for a much longer time than you would ordinarily keep those records).