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A Health Savings Account (HSA) is a tax-exempt account set up with an insurance company, bank or other financial institution or trustee that you can use to pay for certain qualified medical expenses. Employees can open an employer-sponsored Health Savings Account if they are eligible, and people who are self-employed may also qualify for an HSA.

There are several benefits to having an HSA, and a big one is the fact that the contributions you make to the Health Savings Account are tax deductible. So, you’re contributing pre-tax dollars, and as long as you spend the funds on qualified medical expenses, you won’t be taxed on withdrawals. In addition, any earnings from HSA funds that you’ve invested also accumulate tax-free.

You can also save for large medical expenses, such as a surgery or procedure that you will need in the future. Or you could sock away enough money each year to build a high balance that can cover unexpected medical emergencies later.

Think you’re a good candidate for a Health Savings Account? Here’s what you need to know.

You must use HSA funds for qualified medical expenses

For withdrawals to be tax-free, you must spend the funds on “qualified medical expenses” as defined by the IRS. Qualified medical expenses are generally those that would qualify for the medical and dental expense deduction on your federal income taxes. To see a list of qualified medical expenses, see IRS Publication 502.

Find out: 5 Strategies to Minimize Health Insurance and Medical Care Costs

You must have a high-deductible health plan to be eligible

Whether you’re self-employed or have a Health Savings Account through your employer, you must have a high deductible health plan (HDHP) to qualify for an HSA. For 2021 and 2022, the IRS defines a high deductible health plan as one that has at least $1,400 for an individual and $2,800 for a family. Also, for 2021, the HDHP’s annual out-of-pocket expenses can’t exceed $7,000 for an individual, or $14,000 for a family, not including out-of-network expenses. In 2022, that out-of-pocket limit can’t be more than $7,050 for an individual or $14,100 for a family.

You can’t have additional health plan coverage

To be eligible for an HSA, you can’t have any other health coverage, with a handful of exceptions. Other insurance you can have and still be eligible for an HSA includes certain types of liability insurance, insurance for a specific illness or hospitalization insurance that pays a specific amount per day. You’re also allowed to have insurance coverage for accidents, disability, dental care, vision care and  long-term care in addition to your HDHP. You can also have telehealth and other remote care (for plan years before 2022).

There is an annual HSA contribution limit

The amount you can contribute to an HSA depends on the type of HDHP coverage you have, your age, the date you became eligible for an HSA and the date you cease to be eligible. For 2021, you can contribute up to $3,600 if you have an individual HDHP, or up to $7,200 if you have family coverage. For individuals 55 and older at the end of their tax year, the contribution limit is increased by $1,000. Once you are enrolled in Medicare, however, your annual contribution limit is reduced to zero.

Find out: How to Save for Healthcare in Retirement

The CARES Act expanded HSA spending

The Coronavirus Aid, Relief and Economic Security (CARES) act expanded the list of items considered “qualified medical expenses” that may be reimbursed from a health savings account, making menstrual products and over-the-counter medications now reimbursable from HSA accounts.

Your HSA balance rolls over

If you haven’t spent your HSA balance by the end of the tax year, no problem. Your balance rolls over into the next year, every year, without penalty. That way, you can continue to contribute and build up the balance to cover future medical expenses.

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About the Author

Deb Hipp

Deb Hipp

Deb Hipp is a full-time freelance writer based in Kansas City, Mo. Deb went from being unable to get approved for a credit card or loan 20 years ago to having excellent credit today and becoming a homeowner. Deb learned her lessons about money the hard way. Now she wants to share them to help you pay down debt, fix your credit and quit being broke all the time. Deb's personal finance and credit articles have been published at Credit Karma and The Huffington Post.

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