A health savings account (HSA) is an account that’s for medical expenses. Money is deposited into and withdrawn from an HSA, just as it is with other accounts. All the money in an HSA, however, is meant to be used for approved medical expenses. If funds are directed to non-medical costs, penalties may be assessed by the IRS.
Using an HSA to pay for medical expenses has two tax benefits. First, contributions are generally either tax-deductible or made with pre-tax income, both of which reduce the account holder’s adjusted gross income and, therefore, their tax burden. Second, any interest or growth that the account generates is untaxed.
HSAs and flexible spending accounts (FSAs) are both accounts that are used to pay for medical expenses, and they provide similar tax benefits. There are a few key differences between the two types of accounts, though. In general:
There are many approved medical expenses that funds in an HSA might be used for. Just a few examples of expenses that may be approved include the following;
How much an individual saves by using an HSA will depend on their tax bracket. Someone who is in the lowest tax bracket won’t save as much as someone in the highest, but both participants will save when it comes time to pay taxes.
In theory, someone who was in the 39.6-percent tax bracket (the highest bracket for 2016) could save up to 39.6 percent of their contributions to an HSA. If they contributed $3,000, they may save $1,188. This doesn’t include any additional savings on growth that the accounts’ assets generated (the contribution limit in 2016 was $3,350 for individuals and $6,750 for families; those 55 and older could contribute an additional $1,000 to these limits).
People interested in opening a health savings account can talk with a financial advisor. They’re able to explain the details about these accounts, and they can help get accounts set up.
While healthcare costs often can’t be avoided, there are tools available to reduce their impact on your finances. A health savings account is one such tool.