What it means
The account works like a savings or investment account earmarked for healthcare. Contributions can come from the employee, the employer or both, the balance belongs to the individual, and unspent money rolls over year after year rather than being forfeited.
That last point is what separates an HSA from a flexible spending arrangement, where unused funds are usually lost at year end. The tax treatment is the whole attraction.
Contributions reduce taxable income, any interest or investment growth inside the account is untaxed, and withdrawals spent on qualifying medical expenses are untaxed as well. Money taken out for anything else before retirement age is taxed and carries a penalty, so it is not a general purpose savings pot.
For employers, offering an HSA alongside a high deductible plan usually lowers premium costs, and any employer contribution is a deductible business expense. It also changes employee behaviour, since people spending from their own account tend to compare prices in a way they rarely do with a straightforward insurance claim.
Finance teams should note that contributions made through payroll reduce payroll taxes for both sides. In practice many people treat the account as a healthcare emergency fund, keeping enough cash to cover the plan deductible and investing the rest.
Because the balance rolls over and can be invested, some savers deliberately pay small medical bills from their current account and let the balance compound for decades. Receipts have to be kept, since a withdrawal can be matched to a qualifying expense from any earlier year.
The main limitation is eligibility. Contributions are only allowed while the person is covered by a qualifying high deductible plan, and annual limits are set by the tax authorities and adjusted each year.
Once the holder enrols in Medicare they can keep and spend the balance but can no longer pay into it.
In practice
Real-world examples.
Example
A 30 person design agency switches to a high deductible plan and puts $1,200 per employee per year into HSAs. The premium savings more than cover the contributions, and staff keep their balances if they leave.
Example
A consultant with irregular income uses her HSA as a buffer, funding it heavily in strong years. When she needs surgery three years later the deductible is already covered without touching her business account.
Example
A finance manager approaching retirement stops adding to his HSA when he enrols in Medicare but keeps the $48,000 balance invested. He draws on it for dental and long term care costs that his medical cover excludes.
Think of it
“HSA is the abbreviation for Health Savings Account-medical expense savings.
Formula
Calculation
Immediate tax saving = contribution x (marginal income tax rate + payroll tax rate, where the contribution is made through payroll)
An employee earning $90,000 pays income tax at a marginal rate of 24% and payroll taxes of 7.65%. She contributes $6,000 to her HSA through her employer's payroll during the year.
Income tax saved is $6,000 x 0.24 = $1,440 and payroll tax saved is $6,000 x 0.0765 = $459, giving a total saving of $1,440 + $459 = $1,899. The $6,000 sitting in her account has therefore cost her $6,000 - $1,899 = $4,101 of take home pay. If she invests it and it grows at 6% a year for 20 years, $6,000 becomes $6,000 x 1.06 to the power of 20, or about $19,243, and every dollar of that growth is tax free when spent on qualifying care.Case study
Seen in the real world.
This example is illustrative and fictional. Halloway Fabrication, an invented 140 employee metalworking business, faced a 19% renewal increase on its group health cover and could not absorb it. Rather than cutting benefits outright, the invented finance director paired a high deductible plan with an employer HSA contribution of $1,500 per employee.
The premium saving came to roughly $310,000 a year against employer contributions of 140 x $1,500 = $210,000, leaving about $310,000 - $210,000 = $100,000 of net saving. More importantly, employees who had previously ignored the cost of routine scans began asking for prices, and the invented company's claims data showed a drop in the use of the most expensive local providers.
In this fictional account the change was unpopular in year one, when several employees met a higher deductible before their accounts had built up. Halloway responded by paying its whole contribution in January rather than spreading it monthly, and take up of the plan rose the following year.
Watch out
Common mistakes.
- Confusing an HSA with a flexible spending arrangement and assuming the balance is lost if it is not spent by December.
- Contributing while not covered by a qualifying high deductible plan, which creates a taxable excess that has to be corrected.
- Leaving the whole balance in cash for decades when the account can be invested and its growth is tax free.
Questions
People also ask.
Who is allowed to open an HSA?
Anyone covered by a qualifying high deductible health plan who is not also covered by most other health cover and has not yet joined Medicare.
What happens to the money if you change jobs?
The account belongs to the individual, so it moves with them and the balance is unaffected.
Can the account be used for anything other than medical bills?
It can, but before retirement age such withdrawals are taxed and penalised, which usually makes it a poor choice.
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