All contributions to your HSA are tax-deducible, or if made through payroll deductions, are pre-tax which lowers your overall taxable income. Your contributions may be 100 percent tax-deductible, meaning contributions can be deducted from your gross income.
HSA contributions through the employer are a deferral, not a deduction - that it, taxes are deferred until some later date (and as TomYoung alludes to, if the HSA money is spent on qualified medical expenses, it is never taxed at all).
The money you contribute to your HSA is non-taxable, just like it is if you contribute to a traditional 401k, IRA or other interest-bearing account. When you contribute money to an HSA, it decreases your adjusted gross income (AGI) which determines your taxable income.
An HSA plan may save you money through lower premiums, tax savings, and money deposited in your account which can be used to pay your deductible and other out-of-pocket medical expenses in the current year or in the future.
File Form 8889 to: Report health savings account (HSA) contributions (including those made on your behalf and employer contributions). Figure your HSA deduction.
Drawbacks of HSAs include tax penalties for nonmedical expenses before age 65, and contributions made to the HSA within six months of applying for Social Security benefits may be subject to penalties. HSAs have fewer limitations and more tax advantages than flexible spending accounts (FSAs).
So if you're scrambling to find some last-minute tax breaks, maxing out your HSA can be a big help. The best part is, you don't have to itemize to claim the deduction.
The Last Month Rule
There is a testing period of twelve months. This means you must stay eligible through the end of the next year, or else you will face taxes and penalties.
A family contributing the current (2023) maximum to an HSA in the 24% marginal income tax bracket can save up to $1,860. And if both spouses are over age 50, the family can save an additional $480 in income taxes by making the additional $1,000 allowable catch-up contributions each of them are entitled to by law.
Any contributions above the IRS set limit will be considered as taxable income. If you over contribute to your HSA and don't correct it, you may be charged a 6% penalty rate each year on the excess that remains in your account. Although funds in your HSA are tax-free, tax penalties may arise.
Once you turn 65, you can use the money in your HSA for anything you want. If you don't use it for qualified medical expenses, it counts as income when you file your taxes. Six months before you retire or get Medicare benefits, you must stop contributing to your HSA.
You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don't itemize your deductions on Schedule A (Form 1040). Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.
You can repay the incorrect distribution before filing your federal taxes for that tax year. However, if you do not correct the mistake, the unqualified amount will be subject to income tax, and you may also face an additional 20% tax penalty.
The Bottom Line. Medical expenses are inevitable, so it could be a smart strategy to max out an HSA, especially since you don't risk losing the money and can take full advantage of the tax benefits.
By using untaxed dollars in an HSA to pay for deductibles, copayments, coinsurance, and some other expenses, you may be able to lower your out-of-pocket health care costs. HSA funds generally may not be used to pay premiums.
The annual HSA contribution limit for new HSAs is prorated for every month you weren't covered by an HDHP. But under the 13-month rule, you can still contribute the full amount to your HSA, even if you didn't have an HSA-eligible HDHP for the entire year.
What are the potential tax advantages of an HSA? The money you can contribute to these accounts is tax-deductible or pre-tax, and any increase in the value of your account is free from federal taxes — so long as withdrawals are made for qualified medical expenses.
First off, most experts would recommend maxing out HSA contributions before maxing out 401(k) contributions because of the tax advantages that come with the HSA. There's no minimum age for HSA fund distributions, so when you need it to spend money on health care, it's got your back.
An HSA contribution deduction lowers your AGI, which could make it easier for you to pass the 7.5% hurdle. If you contribute more than the annual contribution limit set by the Internal Revenue Service (IRS) within a tax year, those excess contributions won't be tax-deductible.
If you don't have an HDHP, have a family, and require frequent diagnostic medical care, a copay plan may be a better option. Neither an HSA or copay plan is better than the other; you just need to decide which plan meets all of your needs and will benefit you the most.
Myth #2: If I don't spend all my funds this year, I lose it. Reality: HSA funds never expire. When it comes to the HSA, there's no use-it-or-lose-it rule. Unlike Flexible Spending Account (FSA) funds, you keep your HSA dollars forever, even if you change employers, health plans, or retire.
You can't contribute to an HSA if you have Medicare coverage, or a plan that pays its share of a covered service without you having to pay deductibles or copayments first (called “first dollar coverage”).