What is an HSA and how does it work?

Suzannah Rubinstein |

For startup founders and benefits leaders looking to offer the best health benefits, and employees who have just enrolled in their first HSA, it’s important to understand the benefits of Health Savings Accounts and how they work.

Health savings accounts (HSAs) are a type of savings account that allow employees to set aside money to cover future medical expenses, or pay for current ones with pre-tax dollars. HSAs are an important addition to your benefits package, as they offer tax advantages and can be used to cover a wide range of healthcare costs. Let's take a closer look at how HSAs work and the benefits they offer account holders.

How Do Health Savings Accounts Work?

HSAs are essentially savings accounts that can be used to cover a wide range of medical expenses, including doctor's visits, prescriptions, preventive care, and more. Account holders can contribute pre-tax dollars (often through payroll deductions) to their accounts, which grow tax-free and can be withdrawn tax-free to cover qualified medical expenses. We’ve outlined a more complete list of qualified expenses here.

One common misconception about HSAs that’s important to understand is that any funds remaining in an HSA at the end of the year can be carried over to the following year. Many people confuse HSAs with FSAs (Flexible Spending Accounts), which don’t allow you to carry over funds to the next calendar year. The ability to save and invest your HSA balance tax-free over time is one of the primary benefits of an HSA. The average American couple spends over $300K on healthcare in retirement, and using an HSA is the only way to save for healthcare in retirement tax-free, so the sooner employees start saving, the more prepared they’ll be for future expenses.

Who's Eligible for an HSA?

To be eligible for an HSA, you must be enrolled in a high-deductible health plan (HDHP). An HDHP is a health insurance plan with lower monthly premiums and higher out-of-pocket costs than traditional health plans. HDHPs can be HMOs, PPOs, indemnity, or other types of health plans, but they must meet the following requirements to be HSA-qualified. In 2023, an HDHP must have a deductible of at least $1,500 for an individual or $3,000 for a family. These minimum deductibles are set by the IRS, and are up $100 and $200, respectively, from 2022. A deductible is the amount you pay for covered health insurance before your insurance kicks in.

The maximum out-of-pocket amount for an HDHP in 2023 is $7,500 for an individual or $15,000 for a family, up $450 and $900 respectively from 2022. Out-of-pocket costs include deductibles, co-payments, and co-insurance, but not premiums. The maximum out-of-pocket amount associated with HDHPs and HSA eligibility was a protection put in place to ensure that HSAs aren’t only accessible for people who can afford to pay for a lot of healthcare out-of-pocket.

While these guidelines around HSA eligibility cover most scenarios, there are some exceptions related to timing and other health coverage. We break down the specifics here.

Are There HSA Contribution Limits?

Similar to a 401(k), there are limits to how much someone can contribute to their HSA per year. In 2023, the contribution limit for a self-only HSA is $3,850 and the limit for a family is $7,750. These numbers are up $200 and $450, respectively, from the 2022 contribution limits.

HSA Contribution Limits for 2023
Catch-up contributions (age 55 or older)$1,000

To be eligible to make family contributions to an HSA, you must be enrolled in a HDHP with family coverage. Each HSA is actually owned by one person, but if you have family coverage under an eligible HDHP, then you’re able to pay for qualifying medical expenses for the people who are covered by your health plan. Because HSAs are complicated, there are some exceptions. The person can’t have other health coverage that makes them ineligible, and they can’t be claimed on another person’s tax return.

The limits outlined above only apply to HSA account owners who were eligible for the entire calendar year. If there were months that you were ineligible for your HSA, then you have to prorate your contribution limit based on the number of months you were eligible. For example, if you have a self-only HSA and were eligible to contribute to your HSA for 8 months of 2023, you would be able to contribute [8 * ($3,850/12) = $2,566.67].

HSA account owners who are over 55 can also make “catch-up contributions,” which are intended to help people save more as they prepare for retirement. Catch-up contributions can only be made for the HSA account owner themself, so there can only be one catch-up contribution applied per year per HSA account. In 2023, the catch-up contribution amount is $1,000. If you turn 55 during the middle of a year, the IRS considers you 55 for the entire calendar year. However, if you’re ineligible to contribute to your HSA during some months, you must prorate your catch-up contribution the same way you prorated your overall contribution.

HDHP Out-of-Pocket Limits for 2023
Minimum self-only deductible$1,500
Minimum family deductible$3,000
Maximum self-only out-of-pocket amount$7,500
Maximum family out-of-pocket amount$15,000

What Are the Tax Benefits of an HSA?

HSAs are considered to be “triple-tax advantaged.” We’ll explain what that means here so you’ll understand how you’re saving money on healthcare by using an HSA.

First, the contributions you make to your HSA are 100% tax deductible, which means that whatever you contribute to your HSA can be deducted from your annual gross income. By contributing to your HSA, you reduce your annual income taxes.

Second, all the interest you earn in your HSA by investing your balance is 100% tax-deferred. This means that the funds in your account are able to grow without being subject to taxes (unlike other investment accounts), unless you use the funds to pay for unqualified expenses.

The third tax advantage of having an HSA is that your withdrawals from the account are also 100% tax-free as long as you use the funds to pay for qualified medical expenses.

There’s actually a fourth tax advantage to using an HSA. Federal Insurance Contribution Act (FICA) taxes support the federal Social Security and Medicare programs and the total due every pay period is 15.3% of an individual’s wages, half of which is paid by the employee and the other half by the employer. Since HSA contributions are deducted from annual gross income, HSA holders are also able to reduce their FICA taxes by contributing to their HSA.

Understanding Your HSA Is the Key to Unlocking Its Benefits

HSAs are a great way for employees to save for future healthcare expenses and pay for current ones pre-tax. It’s important to understand the intricacies of HSAs to make sure you’re getting the most out of your account, or can explain those benefits to your employees. At Thatch, our goal is to make using your HSA as easy as possible, so saving and paying for healthcare can be seamless. Get in touch with us to learn more about what makes our HSA different.

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