The Tax Benefits of Health Savings Accounts
When you save with a Health Savings Account (HSA), all your funds are tax-free. That means instead of having to pay taxes, you can use that money to help pay for your health care costs.
With the tax benefits of Health Savings Accounts, it's like the government is picking up a part of your health care bills.
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How are HSA funds tax-free?
When you contribute savings to your HSA, you can deposit money directly from of your paycheck before income taxes are taken out. Once the HSA savings is deposited, then the rest of your pay is taxed regularly. Because less of your income is taxed, you pay less in taxes.
Saving with a Health Savings Account gives you a double tax benefit. Besides paying less income tax, you also won't pay any tax on the interest earned by your HSA funds. And once you reach age 65, you can withdraw money from your HSA for any reason without paying a penalty.
To deposit funds into an HSA from your paycheck, your employer must offer a "salary reduction" plan — also called a cafeteria plan. These plans are a part of section 125 of the federal tax code, which allows employers to reduce a worker's taxable income.
What if you can't make pre-tax deposits?
If your employer doesn’t have a cafeteria plan or you're self-employed, you cannot make HSA deposits before income taxes are withheld. But that doesn’t mean you won't get the tax benefits.
Any personal after-tax contributions made to an HSA count towards what's known as an "above-the-line" tax deduction.
This means you can reduce your taxable income by the amount you saved in a Health Savings Account. For example, if you've saved $2,000 in your HSA for the year, then you could subtract that $2,000 from your taxable income on your federal tax return. From there, you'll get a refund on the taxes you paid for your HSA savings.
It's also important to remember that you must be enrolled a high-deductible health plan to open a Health Savings Account. Also, make sure you only withdraw savings to pay for HSA-qualified expenses — otherwise your withdrawal will be taxed like regular income and hit with a 10% tax penalty.
You can also learn more about Health Savings Accounts.