A health savings account (HSA) is an often misunderstood financial planning tool. It is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan (HDHP). Some people confuse it with a flexible spending account (FSA). However, if I told if I told you could grow your account and never pay taxes when you use the funds for qualified medical expenses, you might like that idea. Read on and I’ll give you a hypothetical example. Tax Advantages of HSAs Who doesn’t like a tax deduction? All tax deductions are not equal, however. I will give you a quick primer. Health savings account contributions are similar to qualified retirement plans that you might be familiar with in that they can reduce your taxable earned income. Let’s use a $100,000 stream of income as an example. If you take advantage of an HSA and are eligible for the family maximum contribution in 2016, then you can reduce your taxable income by $6,750 and only pay taxes on $93,250. If you’re over age 55, you can add $1,000 and now pay on $92,250. Single taxpayers could see a maximum reduction of $3,350 ($4,350 if over age 55). The phrase savings account is a bit of a misnomer. Savings accounts usually are associated with periods of less than a year. That distinction affects at what rate you are taxed. Monies held for less than a year are taxed at the same tax rate as your income. If you’re a married filing jointly taxpayer in a $100,000 tax bracket, you are subject to a 25% tax rate on your income before any deductions. Those taxpayers in the highest tax bracket pay 39.6%. (For more from this author, see: How Is Income Taxed Differently Than Wealth?) Monies held longer than a year are categorized as long-term. Long-term gains rates stand at 0%, 15%, or 20%, depending upon income. If you are in the highest tax bracket, you cut your tax rate nearly in half. So why not go one better and make it 0%? You pay no taxes on a health savings account while it is growing. Any funds you withdraw from an HSA for non-qualified medical expenses will be taxed at your income tax rate, plus a 10% tax penalty. In these ways, it is similar to a qualified retirement plan. HSA as an ATM HSAs will dispense the amount you ask for as long as you have money in the account and are using it for qualified medical expenses. Outside of paying the premiums on medical insurance, most people I know don’t budget for co-pays and coinsurance and other sporadic health expenses. That being said, one of the reasons that some people have had to claim bankruptcy has been due to severe medical expenses. For many of us, most of our out-of-pocket expenses for medical care will occur later in life. As I learned from my mom when my dad died, the expenses for his health care did not die with him. So how can you plan for these expenses? Let’s say you’re 45 years old today and contribute the 2016 family maximum of $6,750 for the next 20 years. Additionally, let’s say that hypothetically you are able to achieve a 6% return. At the end of the 20 years you would have invested $135,000 and will now have $263,200.91, nearly doubling your money. Hopefully you wouldn’t need to tap into most of that money until, say, age 85 and would be able to see the money grow even further. (For related reading, see: How Compounding Benefits Your Retirement Savings.) Depending on the company you work for, your only health insurance choice may be a high deductible health care plan or it may be another choice on the menu. Remember that you must elect the HDHP to qualify for the HSA. You may be given a choice of an FSA as well; if your choice is a limited purpose FSA, I suggest hugging your HR professional and your CFO. More on that in the next paragraph. You cannot elect a FSA and a HSA. The FSA is the one that you might hear associated with use it or lose it. The FSA has no growth opportunities to increase your dollar by investing it in the market and seeing it grow with compounding. A limited purpose health flexible savings account allows you to participate in a tax-advantaged FSA while also being able to fund your HSA. FSA monies would be used for your current year qualifying medical expenses. For 2016, there is a $2,550 salary reduction limit per employee imposed by the IRS, but your employer is not required to adopt the maximum amount. It can be less. Have a working spouse who is also eligible? You can double that amount.