N—Health Savings Accounts

Offering an attractive means of funding future health care costs, a health savings account (HSA) can be established by eligible individuals covered by a high deductible health plan (HDHP), provided they are not claimed as a dependent on another person’s income tax return and are not entitled to benefits under Medicare (i.e., have not reached age 65). The 2025 required HDHP must provide for a minimum annual deductible of at least $1,650 for individual coverage and $3,300 for family coverage; and maximum annual out-of-pocket expenses must be limited to $8,300 for individual coverage and $16,600 for family coverage (Rev. Proc. 2024-25). As an exception to these deductibles, preventive care services may be covered on a first-dollar basis.

The “preventive care” safe harbor allows HDHP coverage for items such as periodic physical exams, routine prenatal and well-child care, immunizations, tobacco cessation programs, obesity weight-loss programs, and a long list of health screening services that includes, among others, mammograms and PSA tests (i.e., these services can be provided without regard to the deductibles). If prescription drug coverage provides a benefit before satisfying the required deductible it would prevent tax-deductible contributions to a HSA. Permitted is insurance for a specific disease or illness, accident and disability insurance, and coverage for dental care and vision care. In sum, only preventive care services, permitted insurance, and permitted coverages are allowed in conjunction with a HDHP.

Annual contributions to the HSA are limited to a maximum of $4,300 for an individual, or $8,550 for a family (as adjusted in 2025 for inflation). Account holders and covered spouses, aged 55 and over, may each make additional contributions of $1,000 in 2025. Both the account holders and their employers can make contributions, but total contributions cannot exceed these annual limits. A participant in a health reimbursement arrangement (HRA), or a health flexible spending account (FSA), may, one time per arrangement, make an employer-to-trustee transfer to an HSA. This transfer will be treated as a rollover contribution to the HSA (i.e., it will not count toward the annual HSA contribution limit). In addition, individuals who own either a traditional or a Roth IRA may make a one-time trustee-to-trustee transfer from their IRA to a HSA (referred to as an “IRA-HSA rollover”). This transfer will not be included in the individual’s income, nor will it be subject to the 10-percent penalty tax for premature withdrawals. However, the amount cannot exceed the individual’s maximum HSA contribution limit for the year (in 2025, $4,300 for individuals and $8,550 for families). There is also an additional $1,000 per year contribution allowable for individuals who attain age 55 before the close of the taxable year.

Employer contributions for all similarly situated employees must be “comparable” (i.e., the same dollar amount or percentage of the annual deductible limit). The account is entirely owned by the employee. Because unused funds may be carried over from year-to-year, for many individuals it may be possible to accumulate substantial amounts prior to retirement.

Tax-deferred accumulation of earnings and no requirement to withdraw funds at any particular time makes the HSA particularly advantageous as a savings vehicle for future health care expenses (e.g., expenses incurred after age 65). For example, assume a family is covered by a HDHP. In 2025 this allows a maximum annual deposit into the HSA of $8,550 (indexed by the 2017 Tax Act and increasing as per the so-called “chained CPI”). Contributions to a HSA may
be invested in the same manner as contributions to an IRA (e.g., in stocks and bonds). Of course, the HSA is also available for spending on current medical costs or to reimburse the account holder for incurred health care costs.

HSAs offer substantial tax advantages. Contributions made by an individual are fully deductible from income as an “above the line” deduction (i.e., without regard to whether deductions are itemized). Employer contributions are deductible by the employer, are not taxable to the employee, and are not subject to Social Security and federal unemployment taxes. Earnings within the account are tax-deferred. Distributions are tax-free, provided they are for “qualified medical expenses,” a term that is broadly construed to include items such as braces and nursing home costs (but not over-the-counter medications or cosmetic surgery). Distributions other than for qualified medical expenses are taxable and subject to a 20-percent-penalty tax. Under the Patient Protection and Affordable Care Act of 2010 the penalty-tax was increased from 10 percent to 20 percent for distributions made on and after January 1, 2011. The penalty tax does not apply if the distribution is on account of the beneficiary’s death, disability, or after reaching age 65 (i.e., has become eligible for Medicare).

Lower-paid employees in the lowest tax brackets are less likely to benefit from these tax-deductions. Critics of HSAs maintain that for lower-paid employees with substantial health care costs these tax benefits may prove largely illusory. The perceived cost-shifting of the cost of health care to workers is also of concern when an employer switches from a comprehensive coverage program to a high-deductible health plan in order to reduce premium costs. In response, proponents of HSAs maintain that increases in health care costs have excluded many people (particularly the self-employed) from having any health care insurance; and HSAs, together with HDHPs, will make insurance more affordable. It is also argued that savings will come from engaging the health care consumer in health care choices.

Although payments of health insurance premiums are not considered qualified medical expenses, exceptions allow tax-free reimbursements for premiums paid for a qualified long-term care insurance contract, premiums for COBRA continuation coverage, and premiums for healthcare while receiving unemployment compensation. For those who are eligible for Medicare, taxfree distributions can be made for post-age 65 health insurance such as Medicare Parts A, B, C,
and D, and employer-sponsored retiree health insurance (but not for a Medicare supplement policy). Prior to age 65, HSAs cannot be used to make tax-free reimbursements of an employee's share of health insurance premiums.