Health savings accounts (HSA) are used in conjunction with a high deductible health plan and offer four tax advantages compared to traditional savings and investment accounts:
- Your own contributions to the HSA are tax-deductible.
- Employer contributions to your HSA are excluded from your taxable income.
- Interest, dividends, and gains earned on your funds inside the HSA are not subject to federal tax.
- Distributions from the HSA are tax-free as long as the funds are spent on eligible medical, dental, and healthcare expenses.
Eligible healthcare expenses include prescription medications, prescription eyeglasses, and fees paid to health care professionals or hospitals, just to name a few. With a few exceptions, HSA distributions not spent on eligible medical expenses are taxable.
HSAs can also be used to buy over-the-counter medicines as long as your doctor gives you a prescription for it. Additionally, you can tap into your HSA to buy long-term care insurance or to pay for health insurance premiums when you are unemployed.
Despite their attractive tax advantages, health savings accounts are not for everyone. One drawback is that you’ll need to have a high-deductible health insurance plan to be eligible to open and contribute to an HSA. “High deductible” means you’ll be responsible for paying all or a significant portion of your medical expenses out of your own pocket.