HSAs Can Be Beneficial But Beware of Common Mistakes

A Health Savings Account (HSA) allows federal employees and retirees to contribute and to pay out-of-pocket medical and dental expenses in a tax-advantaged way. In order to contribute to an HSA, a federal employee/retiree must be enrolled in a high deductible health plan (HDHP). Each year the IRS defines the minimum deductible. For 2025, the minimum deductible for self only coverage is $1,650 and $3,300 for self plus one and for self and family coverages.

For the 2025 plan year, the Federal Employees Health Benefits (FEHB) program offers several HDHPs . Federal employees and retirees who are enrolled in a FEHB program-sponsored HDHP have access to an HSA. They cannot be covered by any other health insurance plan including Medicare, TriCare or supplemental health insurance. In addition, employees cannot be enrolled in a health care flexible spending account (HCFSA) offered through FSAFEDS except for a “limited expense” HCFSA (LEXFSA) that pays or reimburses only out-of-pocket dental and vision expenses.  

There are several benefits associated with HSA ownership. This column will discuss these benefits and will also explain the common mistakes that HSA owners are advised to avoid.

How FEHB Program HDHPs Coordinate with HSAs

Like other types of health plans including preferred provider organizations (PPO) and fee-for-service (FFS) plans, an employee or retiree must meet the deductible before the HDHP pays benefits. Before meeting the deductible, the HDHP participant pays the full allowed charge for the medical service. After meeting the deductible, the HDHP participant pays a percentage of the medical service cost (coinsurance), which ranges from between 5 to 20 percent depending on the HDHP.

Nevertheless, an HDHP provides “first dollar coverage” before the deductible is met for preventive care services for the HDHP owner and family members. Preventive care services include but are not limited to: (1) Periodic health evaluations; (2) Routine prenatal and well-children visits; (3) Child and adult immunizations; (4) Tobacco cessation programs; (5) Obesity weight loss programs; and (6) Screening services.

To help pay out-of-pocket costs using tax-free withdrawals from the HSA, a portion of the FEHB program HDHP monthly premiums is automatically contributed to the HSA. This is called the “premium pass-through.” The HDHP “premium pass-through” varies by plan, and ranges from $750 to $1,200 for self only coverage and between $1,500 to $2,400 for self plus one and self and family HDHP participants. In addition, the HSA owner can make voluntary tax-deductible contributions as an “adjustment to income” IRS Form 1040 deduction. There is an annual limit on HSA contributions that includes the HDHP “premium pass-through” contributions and HSA owner voluntary contributions. The 2025 HSA contribution limits are $4,300 for self only coverage and $8,550 for self plus one and self and family coverage. HSA owners aged 55 and older are permitted to contribute an extra $1,000 each year t. 

FEHB program HDHPs have maximum annual out-of-pocket limits. For 2025, these limits are $8,350 for self only coverage and $16,600 for self plus one and self and family coverage.

HSAs Offer a “Trifecta” Tax Advantage

HSA participation results in a “trifecta” (triple) tax advantage:

1. Employee premium contributions that are a part of the “premium pass-through” are made via payroll deduction and deducted from the employee’s gross salary (before federal and state income taxes are deducted), thereby lowering taxable salary and taxable income. Voluntary contributions to an HSA are deductible as an adjustment to income, also lowering federally taxable income.
2. Funds in an HSA accrue earnings – interest, capital gains and dividends,  and these accrued earnings are tax-free when withdrawn to pay qualified healthcare expenses.
3. Withdrawals are tax-free when used to pay or reimburse qualified health care expenses.

HSAs Can Be Considered as a Flexible Retirement Account

Another advantage of HSA ownership is that there are no “use-or-lose” spending restrictions from year-to-year. A federal employee or retiree who owns an HSA is not required to use up the funds in the HSA from year to year. Any unused HSA funds including contributions and earnings carry over from year to year. If a federal employee owns an HSA and leaves federal service, then the departed employee keeps the HSA to be used to pay future qualified healthcare expenses.

Federal employees who own HSAs should keep in mind that their HSAs can be used in retirement to pay or be reimbursed for qualified healthcare expenses. While a federal retiree can no longer contribute to their HSA once they enroll in Medicare, the retiree can make tax-free withdrawals from their HSA in order to pay qualified healthcare expenses throughout retirement including: (1) Reimbursement for Medicare Part B and Medicare Part D monthly premiums; and (2) Long term care insurance premiums.. Additionally, once the HSA owner becomes age 65, non-qualified withdrawals from the HSA can be made for any reason. While federal and state income taxes have to be paid on these non-qualified withdrawals, there is no 20 percent penalty. In that sense, an HSA can be considered as a flexible retirement account that is used to pay for healthcare expense income tax-free.

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Avoiding Common HSA Mistakes

The advantages of  HSA ownership discussed above including the trifecta tax advantage and a flexible retirement account come with some strict guidelines. HSA owners are urged to avoid the following HSA mistakes resulting in taxes and penalties:

1. HSA withdrawals that are used to pay expenses that do not fit the IRS definition of “qualified healthcare expenses.” HSA owners younger than age 65 who make withdrawals to pay or reimburse for nonqualified expenses pay federal income tax on the amount of the withdrawal, plus a 20 percent penalty. Note that an HSA owner can request an HSA withdrawal for any reason. The HSA custodian will not require proof that the requested withdrawal is for a qualified medical expense. Each year an HSA withdrawal is made, the HSA owner receives a Form 1099-SA from the HSA custodian. A copy of the 1099-SA is sent to the IRS. If the IRS begins to review the HSA withdrawals during an audit of the HSA owner’s tax return, then the IRS could demand proof that the HSA withdrawal was used to pay or to reimburse qualified healthcare expenses.
2. Tax impact resulting from naming a non-spouse as an HSA beneficiary. Any individual can be named as an HSA beneficiary. A spouse who is named as beneficiary will inherit their deceased spouse’s HSA and continue to use the HSA in the same tax advantaged way as did their deceased spouse.  But a non-spouse HSA beneficiary is required to immediately withdraw the HSA funds and pay income tax (but no IRS penalty), even if withdrawals are used to pay qualified healthcare expenses. In that sense, the inherited HSA is identical to an inherited traditional IRA that is immediately distributable and taxable to the individual who inherits it.
3. Another cautionary area is Medicare enrollment. Once an HSA owner enrolls in Medicare (normally age 65), the HSA owner can no longer contribute to the HSA. The HSA owner can still make qualified (tax-free) withdrawal from the HSA. When federal employees enrolled in an HDHP associated with an HSA opts to work past age 65 in federal service and desires to contribute to their HSA, they need to be aware of the Medicare rules of application and enrollment in order to avoid an IRS penalty for HSA contribution.
4. HSA owners may also run into penalties if they make HSA withdrawals to pay for qualified medical bills that exceed the actual amount of the bills. For example, they request a $7,000 withdrawal from their HSA in order to pay qualified medical bills and the actual medical expenses total $5,000. The HSA owner neglects to return the $2,000 excess withdrawn funds to the HSA. The return of the excess withdrawn funds to the HSA must be done within the same tax (calendar) year.

Ed Zurndorfer, EA, ATA, CFP®, CLU®, ChFC®, CEBS®, ChFEBC℠: Federal Employee Benefits Expert

A former career Federal employee, Ed has published a staggering 1,200+ separate articles on Federal Benefits and Retirement!
Just “Google” his name, and you are likely to find a plethora of sites that contain his writings. Drawn to its mission to reach, teach
and serve Feds, Serving Those Who Serve is the only financial planning practice with which Ed has chosen to affiliate in over
20 years teaching. In addition to conducting Federal Benefits seminars for Serving Those Who Serve, you can find Ed’s
writings here on our blog in the FedZone, and on Fed-Soup, MyFederalRetirement, FederalNews Radio and NITP.

He is a member of the Maryland Society of Accountants, the National Association of Enrolled Agents, the International Society of Certified Employee Benefits Specialists, the Financial Planning Association, the National Association of Health Underwriters,
and the Society of Financial Service Professionals. Since 1999, Ed has taught many thousands of Federal employees about
their benefits, in person and at Federal agencies all over the country. Ed is a true national treasure.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.