What Is an HSA?

A health savings account (HSA) helps you set money aside for health-related expenses. You might have heard the term before or read about it in your benefits package, but were unsure about what an HSA is and how it works.

Having a better understanding of HSAs may help you decide if it's a viable option for you and your needs.

How Can You Use an HSA?

You can use an HSA to set aside pretax income in order to pay for qualified health care expenses such as prescription drugs, copays, ambulance rides, and dental and vision care. Typically, you cannot use your HSA to pay for your health care premiums. Some banks, financial institutions and health insurance companies offer HSAs.

If one is offered through your health insurance company, you must have a high-deductible health plan (HDHP) to qualify. With an HDHP, you typically pay a higher deductible out-of-pocket before your health insurance plan kicks in. Although the premiums for an HDHP tend to be lower than average, the costs you have to pay before reaching the deductible can add up. Every year the Internal Revenue Service (IRS) establishes minimum deductibles for HDHPs.

How Does an HSA Work?

Before you open an HSA, it's important to understand how they work. Many health care providers offer HSAs. If yours doesn't have that option, you may be able to open your own account. If you qualify and decide to contribute to an HSA, there are maximum yearly limits.

You might be offered an HSA through your employer. If so, check to see if you can contribute through automatic payroll deductions. Some employers will also offer contribution plans in a benefits package. Something else to keep in mind is that your HSA moves with you. It's not limited to an insurance plan or employer, and you can even continue to contribute to your account if you're retired and under 65.

When it comes time to put your HSA savings to use, most plans will give you a debit card that's linked to your account to pay for your qualifying medical expenses.

HSA Advantages, Tax Benefits & Withdrawals

There are a few other key things to keep in mind as you explore your HSA options. For many, an advantage of an HSA is that the contributions you make roll over each year, even if you don't use them. Once you hit age 65 and enroll in Medicare, however, you can't continue to contribute to your HSA. You can still use the funds in it to help cover qualifying out-of-pocket medical expenses, including assisted living costs. HSAs also have some tax benefits.

When it comes to withdrawals, there's one essential rule to keep in mind: If you withdraw money from your HSA to pay for nonqualifying expenses, you will owe taxes and a 20% penalty if you're under the age of 65, according to the IRS. If you're over 65, then you will have to pay taxes on the money you withdraw.

An HSA may be a helpful tool for you. HSAs can be part of a long-term strategy to help you prepare for the costs of medical expenses and help to avoid financial strain if unexpected health issues arise.