Are HSA Contributions Tax Deductible?

Many people ask, "are HSA contributions tax deductible?" The good news is that they are. Health savings accounts (HSA) offer a convenient vehicle to save for medical expenses while taking advantage of tax savings. 

HSA contributions are 100% tax deductible up to IRS limits. For 2023, that's $3,850 for individuals and $7,750 for families. Read on to understand the details, including extra "catch-up" contributions to take advantage of this savings vehicle. 

How Does an HSA Work?

As the name implies, a health savings account is a dedicated savings account for approved medical expenses that carry unique tax advantages. With an HSA, you can contribute funds tax-free. The funds grow tax-free, and if you use them to pay for approved medical expenses, you won't pay taxes when you withdraw them. That's a triple tax benefit.

Generally, qualified medical expenses include deductibles, copayments, coinsurance, medication, etc. HSA-qualified medical expenses include:

• Insurance deductibles
• Insurance copayments
• Medicines, both prescription and over-the-counter
• Procedures not covered by other health insurance, such as a midwife, orthodontics, eyeglasses, chiropractic, or fertility treatments 
• Menstrual products
• Telehealth consultations

Other expenses, like aromatherapy, and personal care products like shampoo, or  baby care products aren’t considered qualified medical expenses. You can review IRS guidelines or consult a tax adviser or CPA for clarification on qualified expenses for your situation.

After age 65, you may withdraw HSA funds for non-medical expenses and pay your standard tax rate. For this reason, some people also use an HSA as a retirement savings vehicle. 

HSA Account Rules

To be eligible for an HSA, you must have a high deductible health plan (HDHP), with a minimum deductible of $1,400 for an individual or $2,800 for a family (as of 2022). The total out-of-pocket costs for an HDPD, including deductible, copayments, and out-of-pocket expenses, can’t be more than $7,050 for an individual or $14,100 for a family.

Unlike other retirement accounts, anyone may contribute to a HSA on your behalf. That means your employer, friends, or family can put money into a HSA for you. Regardless of who contributes, the annual contribution limit for 2023 is $3,850 for individuals. For families, the contribution limit is $7,750. Anyone age 55 or older can contribute an additional $1,000 per year.

How Do I Know If My Tax HSA Contributions Are Tax Deductible?

All HSA contributions are tax deductible up to the IRS limits. However, if, for example, your employer contributes $1,500 to your HSA, you may only contribute up to $2,350 tax-free as an individual ($3,850-$1,500=$2,350).

The earnings from investments made through your HSA as well as those withdrawals for medical expenses are also tax-exempt. 

If you withdraw HSA funds for non-qualified expenses before age 65, you'll have to pay your current tax rate plus a 20% fee. After age 65, you can withdraw funds and only pay applicable current taxes without fees. 

Does an HSA Reduce My Taxable Income?

HSA monthly contributions made directly from your income will reduce your taxable income each month. If you contribute the limit for families of $7,750, you can reduce your taxable income by that amount. If you're over 50, the maximum increases to $8,750.

How Does HSA Tax Deduction Work?

HSAs are known to have a triple tax advantage. Contributions made to health savings accounts are not subject to federal income tax. You will report HSA contributions on the HSA tax form. Then, the funds can be invested and grow tax-free. Finally, if you withdraw funds for qualified medical expenses, you won't pay taxes on that amount. That's a triple tax advantage:

• No taxes on contributions
• Tax-free growth of funds
• No taxes on withdrawals for qualified medical expenses

HSA Tax Deduction Examples 

Suppose you make $100,000 yearly and have an HSA for your family. If you contribute the full $7,750 for the year, your taxable income is reduced to $92,250. Assuming you have no other deductions, your federal income tax requirement would be reduced by nearly $2,300. This will also affect state and local taxes but varies by where you live. 

If that $7,750 is invested and grows at an average rate of 7% a year, after 20 years, you'd have $29,990, or an additional $22,240, tax-free. If instead of a single contribution, you make annual contributions of $7,750, after 20 years, you'd have $347,295. Assuming you use those funds on qualified medical expenses, you won't pay taxes when you withdraw them. 

Advantages of an HSA Account

An HSA offers major advantages, especially around tax savings for medical expenses. Here's why you should consider an HSA:

Triple Tax Advantage

Contributions made to an HSA are tax-deductible, reducing your taxable income. The interest and investment earnings within the account grow tax-free, and withdrawals for qualified medical expenses are also tax-free. This triple tax advantage can lead to significant tax savings.

Control over Healthcare Spending

With an HSA, you have more control over your healthcare expenses. You can use the funds to cover out-of-pocket medical costs, such as deductibles, copayments, and eligible medical services, allowing you to make informed decisions about your healthcare.

No "Use It or Lose It" Rule

Unlike Flexible Spending Accounts (FSAs), HSAs do not have a "use it or lose it" rule. Any unused funds in your HSA at the end of the year roll over to the next year, allowing you to build savings for future medical expenses.

Portability and Long-Term Savings

HSAs are portable, meaning you can keep and use the account even if you change jobs or retire. The funds in your HSA can serve as a long-term savings vehicle for healthcare expenses during retirement, giving you added financial security in your later years.

Investment Opportunities

Some HSA providers offer investment options once your account balance reaches a certain threshold. Investing in HSA funds can potentially grow your savings further, making it an attractive option for those seeking to build a health-related nest egg.

Disadvantages of an HSA

Before opening an HSA, there are a few disadvantages you should consider:

High-Deductible Health Plan Requirement

To qualify for an HSA, you must be enrolled in a high-deductible health plan (HDHP). HDHPs typically have higher deductibles and out-of-pocket costs than traditional health insurance plans. While HSAs can help offset these costs, they may not be the best option for individuals or families with significant healthcare needs who may struggle to meet the high deductible.

Limited Eligibility

Not everyone is eligible for an HSA. To open and contribute to an HSA, you must have an HDHP and cannot be enrolled in other health coverage that is not an HDHP (there are exceptions to this). Additionally, if you are claimed as a dependent on someone else's tax return, you are not eligible for an HSA even if you have an HDHP.

Penalties for Non-Qualified Withdrawals

While HSAs offer tax advantages, there are penalties for using HSA funds for non-qualified expenses. If you withdraw money from your HSA for non-medical purposes before age 65, you'll be subject to income tax on the amount withdrawn, plus an additional 20% penalty. This can discourage using HSA funds for non-medical expenses before retirement.

HSA Vs. FSA 

Both HSAs and FSAs offer tax-advantaged savings vehicles for qualified medical expenses. HSAs offer higher contribution limits and allow you to carry funds forward. However, to qualify, you must be enrolled in an HDHP. FSAs have lower contribution limits, but you don't have to be enrolled in an HDHP. However, with an FSA, you generally can't carry over funds.

Using an HSA

When you signup for a HSA, you will report contributions on the HSA tax return and reduce your taxable income. An HSA builds protection and security for your family in case of medical expenses while offering the opportunity to build retirement savings. With time, the wealth can grow, allowing you greater control over your medical expenses with increased flexibility to choose the providers you want.

Frequently Asked Questions