Health Savings Accounts (HSA’s) have been around for quite some time, but tax/financial advisors are touting their “triple tax advantages” now more than ever. This PayDay will illuminate what a health savings account/HSA is and the tax and financial advantages of funding an HSA.
WHAT IS A HEALTH SAVINGS ACCOUNT/HSA?
An HSA is a bank/mutual fund account which is funded by individuals and/or employers for the purpose of accumulating funds to pay for “qualified medical expenses.” Qualified medical expenses are those which are defined in Section 212 of the tax code, and include medical, dental, and vision expenses, co-pays, scripts, etc. A person is eligible to establish an HSA IF they have a “high-deductible health plan” or “HDHP.” An HDHP is essentially health insurance which has higher deductibles. Insurance companies actually identify which of their medical plans are HDHP’s qualifying for HSA “paired” accounts. Bronze and catastrophic medical plans automatically qualify as HDHP’s. HSA accounts can be set up at banks, mutual funds (Fidelity, Vanguard, Schwab, etc) and most financial institutions.
I THOUGHT A PERSON CAN DEDUCT/WRITE-OFF MEDICAL EXPENSES ON THEIR 1040 FORM ANYWAY—SO WHY THE HSA?
Medical expenses can only be deducted for income tax purposes IF a person “itemizes” their personal tax deductions AND ALSO IF the total medical expenses exceed 7 1/2% of the person’s income level. It is increasingly uncommon for a person to write-off medical expense on their Form 1040, based on current tax law.
So how can a person claim tax deductions for their medical expenses?—–Contribute to a HSA on a tax-deductible basis and then use the HSA account funds to pay for medical expenses. Funding an HSA account is deductible by an individual on IRS Form 8889.
WHAT ARE THE TRIPLE TAX ADVANTAGES OF AN HSA/HEALTH SAVINGS ACCOUNT?
- Contributing to an HSA is tax-deductible—-so money going into the account saves income taxes
- The interest income or other investment income of the funds inside the HSA account are not currently taxed
- Taking distributions from an HSA account to pay for medical expenses is income tax free
A fourth tax advantage of an HSA, seldom discussed but very important, is that HSA contributions made pre-tax by an employee via a payroll tax deduction Section 125 plan OR employer funding/matching of HSA contributions are also deductible for FICA and Medicare taxes—–in that case, the employee saves 7.65% of the payroll deduction in payroll taxes AND the employer also saves their “FICA/Medicare tax” match of 7.65%.
HOW MUCH CAN BE CONTRIBUTED PER YEAR TO AN HSA ACCOUNT?
Maximum allowable contributions to HSA accounts in 2026 are $4,400 to a single account and $8,750 to a “family account.” The allowable funding amounts increase each year based on inflation and are calculated by the IRS. Those total funding maximums include both the individual and employer matching funding components. Individuals who are at least age 55 can contribute an additional $1,000 each, per spouse, over/above the funding caps – so $10,750 to a married couple’s family HSA account during 2026. (See our recent PayDay for 2026 contribution limits for other employee benefits.)
HOW ARE HSA WITHDRAWALS TREATED FOR TAX PURPOSES?
Spending HSA funds on qualified medical expenses are not taxable since that is the purpose of the HSA account. Withdrawals made from an HSA after age 65 and used for non-medical costs are taxable, but do not generate any penalty for being used for non-medical spending—–using HSA funds for non-medical purposes before age 65 does generate an IRS penalty. Many HSA account holders try to minimize spending the funds before age 65 so they can be saved for expected larger medical bills in retirement OR can also be used for retirement funding, similar to an IRA account.
WHO OWNS THE HSA ACCOUNT FUNDS?
The individual owns the HSA account, even if funded all or partially by their employer. If they switch jobs they take their HSA account with them. Unlike flexible spending accounts, HSA account balances not used in a given year carry over to future years—-so if an individual begins funding a HSA account at an early age and does not spend the HSA funds for medical expenses while young, the HSA balance can become significant over time—-especially when invested in a similar manner to how one invests their IRA or 401k plan. Many people choose to invest their HSA funds in the stock market, especially while they are young.
SPECIAL RULES FOR EMPLOYEE-OWNERS OF S CORPORATIONS
A 2% or more shareholder-employee of a S corporation can not participate in a pre-tax Section 125/cafeteria plan like non-owner employees. BUT the S corporation can contribute funds to the HSA accounts of its owner-employees just like it does for medical/health insurance—-it is taxable to the owner-employee on their W-2, BUT then the owner deducts the HSA contribution on their Form 1040 to offset the W-2 income. Additionally, the income reported on the owner-employee’s W-2 form is NOT subject to FICA or Medicare payroll tax purposes. An owner can contribute to their HSA personally, but it is better to have the S corporation fund the HSA since in that manner the income to fund the HSA is exempt from FICA and Medicare taxes.
IF EMPLOYERS FUND HSA’S FOR THEIR EMPLOYEES, TO INCLUDE SOME EMPLOYEE FUNDING OF THE HSA ACCOUNT, MAKE SURE YOUR WRITTEN SECTION 125/CAFETERIAL PLAN DOCUMENT INCLUDES HSA FUNDING AS A BENEFIT OF THE SECTION 125 PLAN.
AccuPay can assist employers who have HSA funding as part of a Section 125 Plan by setting up pre-tax deductions and direct deposit into employee HSA accounts. Contact your Payroll Specialist at payroll@accupay.com or 317-885-7600 for more information.
This PayDay is for educational purposes only and does not constitute tax and/or legal advice. Any links to external resources are for educational purposes only. AccuPay is not affiliated with nor receives any renumeration from any outside sources. Please consult with your tax and/or legal advisor before applying any suggestions made here or through external links.