Your HSA is your best friend
Aside from me, of course.
Here we’ll explore the singular features of a health savings account (HSA), some of which will be a surprise even to most HSA users. We’ll also address the challenges caused by all the restrictions on how you can use an HSA.
An HSA is a tax-advantaged account that helps incentivize saving and investing for medical expenses. The money in your HSA can pay for your own medical expenses as well as those of your spouse, dependents, and certain non-dependent children.
Properly used, an HSA provides the most tax advantages of any account. It has a distinct set of three tax advantages:
Contributions are tax-deductible
Investment earnings are tax-sheltered
Withdrawals for qualifying medical expenses are tax-free
When contributing to retirement accounts, you decide whether to pay tax now (Roth) or later (traditional). But with an HSA, you can completely avoid tax on the amounts you contribute each year, as well as the investments in the account.
You can pay for medical expenses directly from an HSA with a debit card, or you can wait and reimburse yourself later. The delay can be two days or 20 years, as long as you can document the payments and you contributed to an HSA before the expenses were incurred. Documentation isn’t routinely needed — you can reimburse yourself without it. Your documentation will likely never be used, but the IRS could request it if your tax returns were audited.
When you contribute to an HSA, you get a deduction for federal and state income tax. In that way, it’s like contributing to a traditional retirement account. On top of that, HSA contributions let you avoid federal payroll tax — as long as you contribute through payroll deduction, which means your employer deposits it from your paycheck.
For a typical HSA user, let’s say the marginal rate for federal income tax is 22% and the payroll tax rate is 7.65%, for a total of 29.65%. If someone contributed $4,300 in 2025 with those tax rates, they’d save $1,275 in federal tax and possibly more in state tax. A traditional retirement account would provide a smaller deduction: only 22% at the federal level.
Not every American can contribute to an HSA every year. You’re eligible to contribute only if you have a qualified high-deductible health plan (HDHP). If you contribute to your HSA while you have an HDHP, then switch to a non-HDHP, you can still spend from and invest in your HSA for as long as you want. You can resume contributions if you switch back to an HDHP.
A self-only health insurance plan covers you alone, whereas a family plan covers at least one additional person (usually a spouse and children). In order for a plan to count as a qualified HDHP and thus be HSA-eligible, it must have a deductible of at least $1,650/$3,300 (self-only/family), and an out-of-pocket maximum of no more than $8,300/$16,600. Those are 2025 figures and they’re adjusted for inflation each year.
In addition to the two plan-specific requirements, you must have no other health coverage and must not be claimed as a dependent on someone else’s tax return.
Naturally, HDHPs have higher deductibles and lower premiums than other plans typically offered through an employer. People with a wide variety of medical expenses may find an HDHP to be suitable — there’s no simple criterion that many people suggest, like “only use an HDHP if you’re healthy”. The unique tax benefits of an HSA, even if not used for investing, make HDHPs a good fit for more people than they would be otherwise. And many employers contribute to their employees’ HSAs, which is a benefit you forgo if you choose a non-HDHP. You should account for all the benefits of an HSA, which we’ll expand on below, when deciding on your health plan.
Investing in your HSA
Investing in a tax-advantaged account is easy: you can buy and sell as much as you want without worrying about tax implications. What else is there to discuss? We mentioned above that you can reimburse yourself for medical expenses from your HSA at any time in the future. Knowing that, there are three approaches to paying for each medical expense:
Pay directly from your HSA cash balance with the debit card.
Pay from taxable assets (credit card / checking account), but promptly reimburse yourself from your HSA.
Keep investing the money, and wait a long time to reimburse yourself.
Why would you consider waiting to reimburse? Let’s say you have a $1,000 medical expense. If you reimburse yourself promptly, you’ll have $1,000 less in your HSA and $1,000 more in your taxable assets. If you wait to reimburse, you’ll keep the $1,000 in your HSA. Would you rather invest that money in a taxable or tax-advantaged account?
If you have enough cash to pay that medical bill, it can make sense to retain assets in your HSA. Gradually, you would build a large balance in your HSA that could be withdrawn at any time, penalty- and tax-free. Meanwhile, that money would stay in your HSA and enjoy tax-free investment. The ability to withdraw unconditionally is a rare opportunity among the rules for tax-advantaged accounts.
Taken to its extreme, leveraging this approach would involve the following:
Make the maximum HSA contribution every year of eligibility.
Invest the money in your HSA aggressively (i.e., largely stocks).
Pay your medical expenses from taxable assets.
Document all your medical expenses so you can reimburse yourself later.
Doing this for decades could result in an impractically large HSA. But you don’t need to choose between a dichotomy of investing in your HSA or not doing it at all. You can invest some of your HSA contributions each year for long-term needs, and withdraw the rest for recent medical bills. Or if you have low medical expenses but you can max out your HSA, you might naturally be able to invest a large amount each year.
Jargon break
In the context of tax-advantaged accounts, “distribution” is the official word for “withdrawal”. When you see distribution, just think withdrawal. “Qualified distributions” are withdrawals that are penalty-free because they comply with the purposes of the account.
“Earnings” or “investment earnings” refer to the growth in value of investments in these accounts. Now back to the show.
What can you do with all the money invested in your HSA? Fidelity estimates that the average American retiring at age 65 today will spend about $165,000 on health care while covered by Medicare. That figure doesn’t include some potential expenses like long-term care. So one reason to invest in your HSA is for basic long-term planning. More than that, you could use a large HSA balance at any age if you were seeking expensive care outside of your insurance network for a critical need.
What if you have excess funds in your HSA that you and your family won’t need for health care? First, you can reimburse yourself for all your documented past medical expenses. Second, you can use your HSA as a retirement account. Before age 65, withdrawing from your HSA for non-medical expenses would trigger income tax, as well as a 20% tax penalty. But once you reach 65, the penalty expires. You would only owe income tax when you take a non-qualified distribution (i.e., a withdrawal not attributed to medical expenses). Owing income tax isn’t as good as a tax-free distribution, but it’s the same as withdrawing from a traditional retirement account.
Your HSA can be inherited by your spouse tax-free; it becomes their HSA upon your death if you name them as your primary beneficiary. But if you leave your HSA to someone other than your spouse — including your kids — they would owe tax on the full amount. Your HSA isn’t suitable for donating to charity while you’re alive: you would owe tax on distributions even if they’re used for charitable donations. But if the beneficiary of your HSA is a charity, no tax is due when it receives the funds upon your death.
So your HSA has multiple applications: first as a health savings account, then as a retirement account, then — if you want — as a bequest to loved ones or charity. In many scenarios, an HSA is a stealth retirement account that beats retirement accounts at their own game.
Spending from your HSA
You can use your HSA to pay for some expenses directly related to your health plan, like co-pays, co-insurance, and deductibles. But HSAs can pay for a variety of health care expenses that may be surprising. Eligible expenses include eyeglasses and contact lenses, braces, certain OTC medications like aspirin and ibuprofen, childbirth classes, therapy and psychiatric care, guide dog expenses, changes you make to your home for medical reasons, sunscreen, tampons and pads, alcoholism treatment, hearing aids, and out-of-pocket transportation expenses needed to travel to medical care. Certain items are conditionally eligible, such as wigs if your disease or treatment has caused hair loss. A letter of medical necessity from your doctor can greatly broaden the universe of eligible items. You can reference IRS Publication 502 as well as resources like HSA store (a private company) to check whether an item is eligible.
Your insurance premiums are paid the same way when using an HSA-eligible plan. Before age 65 you cannot pay for premiums from your HSA (unless you’re receiving unemployment benefits or using COBRA, the federal program that allows you to keep your health insurance with a group plan after leaving a job by paying the full cost yourself). However, in old age you can pay for some Medicare premiums with your HSA, and at any age you can use your HSA to pay premiums for long-term care insurance. You can no longer contribute to your HSA once you enroll in Medicare (usually at age 65) or Social Security old age benefits (between ages 62 and 70).
Rebel states
Despite all the features I’ve celebrated about HSAs, there is some potentially bad news. HSA contributions are tax-deductible with regard to federal income tax, federal payroll tax, and state income tax in every state but two. In California and New Jersey, HSA contributions and earnings receive no state tax breaks. Despite the federal government creating the HSA as a tax-advantaged account over 20 years ago, CA and NJ do not agree and will tax you like you’re investing in a taxable account. The benefits of HSA investing are weaker if you plan to live in either of these states for a long time, because they have some of the highest tax rates in the country.
If you invest in your HSA and move to CA or NJ, you could buy a US Treasury bond fund to avoid state tax because they’re taxed only at the federal level. Since your HSA is federally tax-advantaged, income from US Treasury bonds in your HSA would not be subject to any tax. However, capital gains associated with US Treasury bonds or bond funds would still be taxable. Perhaps the worst part is that because CA and NJ are flouting the rules, you don’t get a tax form for investments in your HSA — you have to re-create it yourself. The benefit of avoiding state tax would have to be weighed against the drawbacks of not investing in your preferred portfolio.
More about your HSA
There are some gritty details that no one needs to read if they’re here for general info about HSAs. But if you’re reading because you want to use an HSA immediately, or improve how you’re using your HSA, you may want to check out the footnote at the bottom about contribution limits.
In 2025, the maximum HSA contribution is $4,300 for self-only coverage and $8,550 for family coverage. Those figures are adjusted for inflation each year. HSA owners over 55 are allowed another $1,000 in “catch-up contributions”, so their maximum is $5,300 or $9,550. The date on which you turn 55 doesn’t matter: anyone born in 1970 can start making catch-up contributions to their HSA in 2025.
Please keep in mind that you don’t need to max out your HSA to benefit from it. You get a tax deduction regardless of how much you contribute.
If your employer contributes to your HSA, their contribution uses part of your annual maximum. So if your max is $8,550 and they contribute $400, you can directly contribute up to $8,150.
You don’t have to keep your HSA funds with your employer’s HSA provider. You can open your own HSA and periodically transfer the assets there. I do this at the beginning of every year, even when staying with the same employer. I recommend using Fidelity for your personal HSA. Their HSA offers (a) no account fees, (b) no requirement to keep a certain cash balance, and (c) a full range of commission-free investment options, including ETFs. Lively is also a great option.
Summary
There are a few approaches to managing your HSA:
Simplest — Always pay your medical expenses from your HSA, either directly or with a prompt reimbursement. Invest the money that remains, if any.
Intermediate — Pay some medical expenses from your HSA, but deliberately set aside some of your contributions for long-term investment. To simplify, pay small expenses immediately from the HSA, while saving documentation of lower-frequency, larger bills.
Most complex — Pay for all your medical expenses from taxable assets (e.g., credit card and checking account). Invest all your HSA contributions, and keep documentation of medical expenses so you can reimburse yourself.
The intermediate approach is probably the best 80/20 strategy for most people (80% of the benefit, 20% of the effort).
The benefits of an HSA are:
Tax-deductible contributions, tax-sheltered investment, and tax-free qualified distributions.
Potential employer contributions, which you receive only if you choose an HSA-eligible health plan.
The ability to spend on health care from your checking account — while getting credit card rewards if you use a credit card — and reimburse yourself from the HSA in the future. With enough qualified expenses incurred over time, your HSA becomes a tax-free investment account that you can withdraw from at any time, penalty- and tax-free.
HSA contributions through payroll deduction avoid federal income tax and federal payroll tax. Your traditional retirement account contributions avoid income tax but not payroll tax.
The ability to withdraw penalty-free for non-medical reasons after age 65 (like a traditional IRA), but having still avoided federal payroll tax on the front end. Investing in an HSA is strictly better than doing so in a traditional IRA unless (a) you withdraw the money prematurely and owe a penalty, (b) you want to donate the money before death, (c) you plan to leave the money to a non-spousal person upon death, or (d) you’re a CA or NJ taxpayer.
Qualified distributions include health care expenses for your spouse and dependents, and long-term care insurance premiums. During old age, they include some Medicare premiums.
See you next week!
Further resources
Every Money IRL post is organized in The Omni-Post, and all vocab terms are here.
Check out these videos from The Retirement Nerds for more HSA details and another perspective. This video compares the HSA to other health care accounts.
The link to Fidelity’s retiree health care estimate is here.
You can use your HSA to pay premiums for qualified long-term care insurance. Check out these links to learn more. There’s an age-based limit on the amount you can pull from your HSA to pay these premiums. Older age grants you higher limits. See the instructions for Schedule A (Form 1040) for the limits at each age.
Read these links to learn more about the last month rule, which is discussed in the footnote.
See this post on how much your returns are boosted by sheltering your investments from tax.
We have a quick overview of tax basics, which covers terms like “payroll tax” that were used above.
To learn more about investing in your HSA and elsewhere, please check out the gentle intro to investing.
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Big footnote on contribution limits
We covered contribution limits above: $4,300 for self-only coverage and $8,550 for family coverage, plus $1,000 for those over 55. But if you don’t have a high-deductible health plan (HDHP) for the entire year, you may have a reduced HSA maximum.
Let’s say you change jobs in May and change your health insurance on June 1 from an HDHP (at your old job) to a non-HDHP (at your new job). HSA eligibility is determined on the first of each month, so you would be eligible for HSA contributions in January through May, the first five months of the year. This would reduce your maximum to 5/12 of whatever maximum would otherwise apply to you. You could still contribute to your HSA in the latter part of the year, but only up to your reduced limit.
This simple pro rata calculation is often how you determine whether your maximum contribution is reduced. But there is a last month rule: if you’re covered by an HDHP on December 1, you’re eligible to contribute the maximum regardless of when that coverage began. So if you switched from a non-HDHP to an HDHP on October 1, you would be eligible to contribute the full maximum, not just the pro rata 3/12 of the maximum.
However, this carries a condition. In order for those contributions to be compliant, you must remain eligible for an HSA for 12 months (the “testing period”). So if you switched to an HDHP on October 1 and took advantage of the last month rule by maxing out your HSA, you would need to stay with an HDHP until the following October 1. If you didn’t, you would need to withdraw the overcontribution, and you would owe income tax as well as a 10% tax penalty. The last month rule applies in the same way when switching between single coverage and family coverage.
If you’re uncertain about whether you’ll stay on an HDHP every month during the testing period, the safe approach is to just abide by the pro rata rule. If your HDHP coverage started on October 1, you could still contribute 3/12 (or one quarter) of the annual maximum for that year.
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Wow this one was so helpful!! Too bad they don’t make HSAs for cats