HSA Rules: Everything You Need to Know

Health Savings Account (HSA) rules exist for both employers and employees governing how HSAs are established and administered. An HSA allows employers and employees to put aside pre-tax dollars that can be used for qualifying medical expenses. Health Savings Accounts were established in 2003 as an addition to the Medicare Prescription Drug Improvement and Modernization Act.

Health Savings Plans have become a viable option for those who want to better manage health care costs. An HSA is a combination of high-deductible insurance plans covering a person's health with savings accounts that are tax-friendly.

What Are the Advantages and Disadvantages of a Health Savings Account?


  • With pre-tax dollars stored in an HSA, the money can be withdrawn to defray the cost of medical expenses such as copays, deductibles, medical equipment, and prescribed medications.
  • Money contributed to a Health Savings Account is tax-deductible.
  • While the money is in the account, it continues to grow tax-free. Whether the money is earning interest or an individual invests the money in mutual funds, bonds, or stock, it remains tax-free when it's withdrawn for medical expenses.
  • Funds in a Health Savings Account do not expire.
  • The account will remain with the owner regardless of changing jobs, replacing an insurance plan, or retiring.
  • Money in a Medical Savings Account (MSA) can be carried over to a Health Savings Plan.
  • A Health Savings Account distribution does not have to be taken in the same year the medical expense was incurred.
  • For those who are healthy, a Health Savings Account can serve as a future retirement plan. Because of the tax structure of an HSA, a Health Savings Account is more beneficial to have, in terms of return, versus a Roth IRA. For example, funds withdrawn from a Health Savings Account for qualified medical expenses remain tax-free while money withdrawn from a 401(k) is taxable.
  • A Health Savings Account (HSA) has its own set of rules about carrying over policies and contribution limits. An HSA should not be confused with a Flexible Spending Account (FSA) or a Medical Savings Account (MSA), as these have their own sets of rules.


  • The rules for setting up an HSA are stringent and worth investigating to decide if contributing to a Health Savings Plan is beneficial to your specific needs.
  • Health Savings Account distributions are not eligible for health coverage expenses incurred prior to opening the account.
  • While Health Savings Accounts are a positive way to increase financial stability with tax-free contributions, it can be an expensive venture that not everyone can afford, as the point of building the account is to not use the funds. This means individuals must have access to other forms of cash on hand to pay for out-of-pocket medical expenses and deductibles.
  • The money can be used only for medical expenses; otherwise, the account is subject to a penalty. For example, a withdrawal made for non-qualifying medical expenses prior to the individual becoming eligible for Medicare will incur a 20 percent penalty, and the funds are subject to income taxes.
  • For individuals reaching age 65 or who become eligible for Medicare, if a withdrawal is made for a non-medical expense, the 20 percent penalty is waived but the funds are subject to federal income tax.
  • Contributions to a Health Savings Plan are possible for individuals up until they reach Medicare eligibility. This is usually age 65, but Medicare eligibility can occur if an individual qualifies for disability with the Social Security Administration prior to turning 65.
  • Although age 65 doesn't automatically disqualify an individual from participating in a Health Savings Account, if the person enrolls in Medicare as their primary source for their insurance, they will be disqualified.

What Are the Eligibility Requirements for a Health Savings Account?

A Health Savings Account has a few rules and regulations that decide if an individual is eligible. The list below includes some, not all, of the eligibility requirements.

  • Those individuals covered by a high-deductible health plan are eligible to open an HSA and contribute to it if they are covered under the health plan the first day of the month.
  • An HSA can be opened if an individual does not have coverage under any non-High Deductible Health Plan or first dollar coverage for health insurance prior to the deductible being met.
  • Individuals have the option of carrying separate coverage for services such as vision care, disability, dental services, long-term care, or accidents. These are not included as part of the deductible.
  • Use of a general purpose Flexible Spending Account (FSA) is prohibited. A limited purpose FSA for services such as dependent care, vision, and dental are allowed.
  • Individuals not enrolled in Medicare are eligible to open a Health Savings Account and contribute to it.
  • Any individual who is not claimed as a dependent on another individual's tax return can take part in an HSA.
  • Contributions can be made to an HSA by employers, individuals, and family members.
  • The contribution limit, from all sources, cannot exceed the contribution limit for the calendar year. Any amount that exceeds the calendar year limits is to be included in the gross income figure for the individual. If this is not done, then it must be filed on the tax return for the individual as "other income."
  • A one-time, tax-free contribution to a Health Savings Account is allowed using funds from an IRA or Roth IRA.
  • Distributions must be reported on Form 8889 and Form 1040.
  • Upon the death of the HSA account holder, the ownership may be transferred to a named beneficiary as estate income or on a tax-free basis to the spouse.

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