In a NutshellContributing to a health savings account allows you to set money aside for health-related expenses, while potentially deducting those contributions from your federal income taxes. But to be tax-deductible, HSA contributions must meet certain criteria — including being made by a certain deadline
This article was fact-checked by our editors and CPA Janet Murphy, senior product specialist with Credit Karma. It has been updated for the 2020 tax year.
Paying taxes every year may not be your favorite pastime, but you still have time to reduce your tax bill and certain out-of-pocket expenses.
One way is to contribute as much as you can now to a tax-advantaged health savings account — an account where you can set aside pretax money to pay for qualified medical expenses not covered by insurance. If you’re eligible to participate in an HSA, you can contribute right up until April 15, 2021, the expected deadline for filing and paying your 2020 federal income taxes (unless the deadlines changes, as it did in 2020 for 2019 returns). Putting money into this account over the next few months can count toward your 2020 federal income tax return.
But that’s not the only benefit: An HSA can also lower your healthcare costs. Here’s how to use an HSA to save money throughout the year, especially come tax time.
- What is an HSA and who can qualify?
- How an HSA works
- Tax benefits of an HSA
- HSA deadlines and contribution limits
What is an HSA and who can qualify?
An HSA is a type of tax-exempt savings account that allows eligible taxpayers to set aside pretax dollars to pay for qualified medical expenses not covered by insurance. Not everyone qualifies to have an HSA.
You could qualify for an HSA if …
- You’re covered by a medical insurance plan classified as a high-deductible health plan, or HDHP.
- You can’t have any other insurance besides your HDHP (though there are exceptions, such as a policy covering only a particular disease).
- You aren’t enrolled in Medicare.
- You can’t be claimed as a dependent on any other person’s federal tax return.
An HDHP is a plan that has a deductible of at least $1,400 if you’re single or $2,800 for a family in 2020, meaning you may have to pay at least this amount out of your own pocket before your health insurance starts paying for covered services. In addition, the total of annual deductible plus other out-of-pocket expenses can’t be more than $6,900 for self-only coverage, or $13,800 for family coverage. For 2021, the deductible amounts will remain the same as the 2020 limits, but out-of-pocket maximums will increase to $7,000 for self-only coverage and $14,000 for family coverage.
If you qualify to have one, you can use HSA funds to pay for copayments, monthly premiums, coinsurance, deductibles and other qualified expenses. Qualified medical expenses can also include medical and dental expenses you paid during the tax year — even if the services were provided before this tax year. Nonessential healthcare services (for example, certain cosmetic surgery) don’t qualify, but healthcare costs related to treatment to prevent or reduce symptoms of a physical or mental disability or illness may qualify.
How an HSA works
If you qualify for an HSA, you can sign up for the account through your employer, if it offers the plan, or through a health insurance company. Banks and other financial institutions also offer individual accounts. You can sign up for an HSA at any time during the plan year as long as you meet the eligibility requirements.
Once your HSA is set up, you can make contributions to it and withdraw money to pay for qualifying healthcare costs or to reimburse yourself for qualifying costs you’ve already incurred. At the end of the year, the account’s trustee will send you an IRS Form 1099-SA, which will detail your total HSA distributions. You may also receive a Form 5498-SA if you made any HSA contributions on your own. You’ll then need to file IRS Form 8889 with your tax return to report all the distributions you’ve taken from your HSA for qualified medical expenses and other expenses that may not be tax-deductible.
Keep good records of all your expenses throughout the year to help ensure the information you provide the IRS is accurate and that you aren’t hit with a surprise tax bill later on.
What medical expenses can you pay with an HSA?
You can typically use an HSA to pay for the same types of expenses that would be included in a medical and dental expense deduction (if you could qualify to take one). Here are some of the things that an HSA may cover.
- Over-the-counter drugs prescribed for you
- Birth control pills prescribed for you and vasectomies
- Medical supplies such as bandages and lactation expenses such as breast pumps and other supplies
- Dental visits, tooth cleanings, fillings and other treatment
- Costs of inpatient treatment for drug addiction
- Vision care such as exams, glasses and contact lenses needed for medical reasons, and saline solutions and enzyme cleaners for lenses
- The expenses involved in buying, training and maintaining guide dogs or other service animals that help people with hearing, vision or other physical disabilities
- Lab fees that are part of medical care
- Costs of special education for children with learning disabilities (with a doctor’s recommendation)
How long do you have to use the money in your HSA?
Unlike a flexible spending account, HSAs aren’t use-it-or-lose-it accounts. You can withdraw the money from an HSA at any time, though only the amount used to pay for qualified medical expenses is tax-free. Any amount left over in the account at the end of the year rolls over to the next year.
Tax benefits of an HSA
HSA contributions are typically tax-deductible. Even if a family member or spouse contributes money to your HSA, you can claim it as a deduction, which will reduce your adjusted gross income. And you can claim this deduction even if you don’t itemize your deductions.
If your employer contributes to your HSA, you may not have to include the amount in your gross income while calculating taxes.
The money in the account is yours to keep even if you change jobs or stop working. Withdrawals may be tax-free as long as you use them to pay for qualified medical expenses.
Another advantage is that HSAs earn interest, which isn’t taxed.
HSA deadlines and contribution limits
Of course, HSAs come with rules and limitations. For example, you can’t just contribute however much you want to your HSA.
For 2020, the maximum amount you’re allowed to contribute to an HSA is $3,550 if you’re single and $7,100 for a family account. For 2021, the limits will be $3,600 for self-only coverage and $7,200 for family coverage. You may be able to add an extra $1,000 to your account as a catch-up contribution if you’ll be age 55 or older at the end of the tax year. If your employer contributes to your HSA, the total of employer contributions and your own contributions can’t exceed the annual HSA contribution limits.
If your total HSA contributions exceed the annual contribution limit, you won’t be able to deduct the excess amount. Plus, you may face a penalty of 6% on the excess contributions unless you withdraw the money and any income earned on the withdrawn contributions by the April 15 filing deadline. If you don’t withdraw the excess amount and are subject to the penalty, you’ll need to file a Form 5329 to report it to the IRS.
There’s also a deadline for making HSA contributions that will count toward the current tax year. The good news: It’s a longer deadline.
The deadline to make contributions to an HSA for a tax year is typically April 15 of the following year. This means that for 2020 taxes, you can contribute until April 15, 2021. If you haven’t maximized your HSA contributions yet, consider using the extra time to do so and to get as big a tax break as possible.
When you can make changes
If you’ve enrolled in an HSA through an employer-sponsored health plan, check with your HR department about whether you can make midyear changes to your contribution. If your employer does allow changes, you may be able to increase your HSA contribution by adjusting the amount of your payroll deduction or the pretax amount that’s withdrawn from your paycheck and deposited into your HSA.
If you have an HSA through a bank or financial institution, it may allow you to change your contribution at any time during the plan year. Some banks allow you to do a one-time rollover or transfer of funds from your IRA or even multiple transfers from another HSA into your existing HSA.
What is the tax penalty for withdrawing money from an HSA that isn’t used for qualifying healthcare costs?
You pay an additional 20% tax on money you use for anything other than qualified medical expenses.
But if you’re 65 or older, there is no tax penalty on any money you withdraw from your HSA to cover non-healthcare costs.
If you’re dreading a potentially high tax bill in April, remember there’s still time to take some action to minimize what you might owe. Use the next few months to take advantage of any tax deductions available to you.
An HSA is a great option if you’re eligible, because the contributions typically are tax-deductible for qualified medical expenses. There’s also the bonus of not paying taxes on money coming out if withdrawals are used for qualifying medical expenses. If you have a high-deductible healthcare plan, you can use the money in your HSA to pay your deductible, which will reduce your out-of-pocket costs.
So, if your HSA isn’t funded to the maximum contribution limit, consider setting aside as much money as possible between now and the tax-filing deadline in April to hit that threshold and reap the highest tax savings you can. You can learn more about HSAs in IRS Publication 969.
Internal Revenue Bulletin: 2019-22 | IRS Notice 2004-2 | HealthCare.gov, Health Savings Account (HSA) | HealthCare.gov, Deductible | IRS Publication 502, Medical and Dental Expenses | IRS Form 1099-SA, Distributions from an HSA, Archer MSA or Medicare Advantage MSA | IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans | IRS Form 8889, Health Savings Accounts (HSAs) | IRS: Credits and Deductions for Individuals | IRS: Filing and Payment Deadlines Questions and Answers
A senior product specialist with Credit Karma, Janet Murphy is a CPA with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.