How Employees Save When Participating in an HSA

September 21, 2020

Health savings accounts (HSAs) are valuable savings tools for your short-term and long-term needs. But how do you save with them? HSAs have a triple-tax advantage, but what do those advantages mean for you? We’ll break down the three-pronged savings potential of an HSA so you can better understand the perks of HSA participation. 

How you save with your HSA

Tax-free contributions

Funds you (or your employer) contribute to an HSA are contributed tax-free. For example, if you participate in an HSA through your employer, your funds are being withdrawn from your salary before they are taxed on the federal level (and also on before they’re taxed on the state level in most states). In that regard, an HSA is similar to a flexible spending account (FSA)

One of the additional perks of an HSA is that the account is yours. Unlike with an FSA, your contributed HSA funds all roll over from year to year and stay with you, even if you change employers. 

Tax-free earnings from investment and interest

Your HSA funds won’t sit idle. Your funds can grow one of two ways: by collecting interest in your HSA’s cash account or by investing your funds in your HSA’s investment account. The good news is that you won’t have to pay taxes on any earnings through investment or interest. The investment potential of an HSA makes these accounts comparable to a 401(k) or IRA.

Tax-free withdrawals for eligible expenses

When you purchase HSA eligible expenses with your HSA funds, these purchases aren’t taxed. And you gained even more flexibility with your HSA funds when the CARES Act permanently reinstated over-the-counter expenses as eligible expenses. Common household items such as pain relief medications, cold and flu products, and allergy products are now eligible for your HSA funds. 

You gain additional spending flexibility when you turn 65. Prior to age 65, if you spent HSA funds on an ineligible expense, your purchase would be taxed and face a 20 percent tax penalty. However, once you’re 65, you would no longer face a 20 percent tax penalty (although funds spent on ineligible expenses would be taxed).

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