Health Savings Account (HSA)
What it is:
Health savings accounts (HSA) are tax-free savings accounts connected to high-deductible health plans (HDHP). HSAs are used to cover healthcare-related expenses not covered by an HDHP.
How it works (Example):
Individuals with HDHP pay small annual premiums for health coverage with a sizeable deductible (generally $1,500 or more). As a result, this type of plan allows holders to maintain and contribute to an HSA individually or as part of a group plan administered by an employer.
HSA contributions are tax deductible and also accrue interest free of tax. Withdrawals are tax-free provided that the money is used for health-related expenses, and the balance of the account rolls over from one year to the next. Once the account holder reaches retirement age, he/she is eligible for distributions from the HSA similar to those that are made from a traditional IRA.
Why it Matters:
It is important not to confuse an HSA with a health reimbursement account (HRA), which is a savings account funded and managed by an employer for reimbursing employees for expenses not covered by a group plan. HSA holders are allowed to contribute only a certain amount each year, and any withdrawals used for purchases other than health expenses are taxed as regular income.