HSA money is tax-free when you use it for medical expenses, but the tax treatment depends on how you contribute and what you spend it on

A Health Savings Account (HSA) is a savings account tied to a high-deductible health insurance plan. Money you put into an HSA is not taxed as income, money that grows inside the account is not taxed, and money you withdraw to pay for may have access to medical expenses is not taxed. That triple tax advantage is what makes an HSA different from a regular savings account.

The catch is that the tax-free treatment only applies to contributions, growth, and withdrawals that follow the rules. If you withdraw money for something other than a may have access to medical expense, you owe income tax on that withdrawal plus a 20 percent penalty — unless you are over 65, in which case you owe the income tax but not the penalty.

Key Takeaways

  • Contributions to an HSA reduce your taxable income for the year, whether you contribute through payroll deduction or directly to the account.
  • Interest and investment gains inside an HSA are never taxed, even when you withdraw the money.
  • Withdrawals for may have access to medical expenses — doctor visits, prescriptions, dental work, vision care, and many other health costs — are tax-free and penalty-free.
  • Withdrawals for non-medical expenses are taxed as income and hit with a 20 percent penalty, except after age 65 when the penalty goes away.
  • You can use an HSA as a retirement account by letting the money grow and withdrawing it tax-free for medical expenses at any age.

How contributions reduce your taxes

When you contribute to an HSA, that money comes off the top of your taxable income. If you earn $50,000 and contribute $3,850 to an HSA in 2024, you only report $46,150 as taxable income. The IRS treats HSA contributions the same way it treats traditional 401(k) contributions — they lower what you owe.

This works whether you contribute through payroll deduction (your employer takes the money from your paycheck before taxes) or whether you contribute directly to the account yourself. If you contribute directly, you claim the deduction on your tax return using Form 1040 and Schedule 1. Either way, the contribution reduces your federal taxable income, and in most states, your state taxable income as well.

The annual contribution limit for 2024 is $4,150 for individual coverage and $8,300 for family coverage. These limits change each year. If you contribute more than the limit, the excess is taxed as income and you owe a 6 percent penalty on the overage.

Why growth inside the account is tax-free

An HSA can hold cash, or you can invest the money in mutual funds or other securities. Any interest, dividends, or capital gains the account earns are not taxed while the money sits in the account. This is different from a taxable brokerage account, where you owe tax on gains every year.

Over time, this tax-free growth adds up. If you contribute $3,850 a year for 20 years and the account averages 5 percent annual returns, the tax-free compounding means you end up with significantly more than if the same money were in a regular savings account and taxed on the gains each year.

may have access to medical expenses that come out tax-free

The IRS publishes a list of may have access to medical expenses. The main categories are doctor visits and hospital care, prescription medications, dental and vision care, mental health treatment, and medical equipment and supplies. You can withdraw money tax-free for your own medical expenses, your spouse's, or your dependents' — even if they are not on your insurance plan.

Common may have access to expenses include copays, coinsurance, deductibles, prescription drugs, eyeglasses and contact lenses, hearing aids, crutches, wheelchairs, insulin, and physical therapy. Over-the-counter medications like pain relievers and cold medicine are also may have access to, as long as you have a prescription from a doctor (the prescription does not have to be filled at a pharmacy — a doctor's written order counts).

Long-term care insurance premiums are may have access to expenses up to certain limits. Cosmetic surgery is not may have access to unless it is reconstructive — for example, after an injury or illness. Gym memberships and general wellness programs are not may have access to, but specific treatments for a diagnosed condition are.

What happens if you withdraw money for non-medical reasons

If you take money out of an HSA and use it for something other than a may have access to medical expense, you owe income tax on that withdrawal. You also owe a 20 percent penalty on top of the income tax. So if you withdraw $1,000 for a non-medical expense and you are in the 22 percent tax bracket, you owe $220 in income tax plus $200 in penalty, for a total of $420.

The penalty does not explore after you turn 65. At that point, you can withdraw money for any reason and only owe income tax on the non-medical withdrawal — the same as you would with a traditional IRA. This is why some people use an HSA as a retirement savings account: they contribute the maximum each year, invest the money, and let it grow tax-free. If they need it for medical expenses, they withdraw it tax-free. If they do not need it for medical expenses, they can wait until 65 and withdraw it for anything, paying only income tax.

Keeping records to prove expenses are may have access to

You do not have to submit receipts to the HSA provider when you withdraw money, but you should keep them. The IRS can audit your HSA and ask you to prove that the expenses you paid for were actually may have access to medical expenses. If you cannot show documentation, the IRS can treat the withdrawal as non-medical, which means you owe the income tax and penalty retroactively.

Save receipts, explanation of benefits statements from your insurance company, and invoices from doctors and pharmacies. Keep them for at least three years, though the IRS can go back further if it suspects fraud. Many HSA providers offer tools to track and categorize expenses, which can help you stay organized.

HSA vs. FSA: the tax difference

A Flexible Spending Account (FSA) is similar to an HSA in that contributions are pre-tax and withdrawals for medical expenses are tax-free. The main difference is that FSA money does not roll over year to year — you use it or lose it. An FSA also does not let you invest the money; it sits in a cash account. And an FSA is not portable; if you leave your job, the account closes.

An HSA is yours to keep even if you change jobs or retire. You can invest the money and let it grow. You can carry the balance forward indefinitely. For these reasons, an HSA offers more tax advantages over time, especially if you do not spend all the money in a given year.

Frequently Asked Questions

Can I use HSA money to pay my health insurance premium?

No, not for regular health insurance premiums. You can use HSA money to pay for COBRA continuation coverage, long-term care insurance premiums (up to certain limits), and health insurance premiums while you are receiving unemployment benefits. But you cannot use it to pay your monthly health insurance bill.

Do I have to spend HSA money in the same year I contribute it?

No. Unlike an FSA, an HSA has no "use it or lose it" rule. You can contribute money one year and withdraw it for medical expenses five years later. The money can stay in the account and grow indefinitely. You can also reimburse yourself for past medical expenses years after you paid them, as long as you have kept the receipts.

What if my employer contributes to my HSA?

Employer contributions to your HSA are not taxed as income to you. They reduce your taxable wages the same way your own contributions do. The total of your contributions plus your employer's contributions cannot exceed the annual limit without triggering the 6 percent penalty on the overage.

Can I claim the HSA deduction on my taxes if my employer took the money from my paycheck?

No. If your employer deducted the contribution from your paycheck before taxes, the deduction already happened. You do not claim it again on your tax return. You only claim the deduction on your return if you contributed the money yourself, out of pocket, after taxes.

What if I withdraw money and later find out the expense was not may have access to?

You owe income tax and the 20 percent penalty on that withdrawal. You can file an amended return to report the non-may have access to withdrawal and pay the tax and penalty. If the IRS discovers it during an audit, you will owe the tax, penalty, and potentially interest on the unpaid amount.