How does an HSA work?

Every other account gives you two of three breaks. An HSA gives all three:

Going in. Contributions are deductible, or come straight out of payroll pre-tax, which also avoids payroll taxes.

While invested. Dividends, interest and gains are never taxed year to year.

Coming out. Withdrawals for qualified medical expenses are entirely tax free, at any age.

A traditional 401(k) taxes the withdrawal. A Roth IRA taxes the contribution. A taxable brokerage account taxes the growth. The HSA is the only one that skips all three, which is why it is worth funding before almost anything except a full employer match.

This is the part most people miss. HSAs typically hold cash by default, often earning close to nothing, and many providers require a minimum balance before investing is enabled.

If you can pay routine medical costs from ordinary income, leaving the HSA to compound turns it into a long-horizon investment account with better tax treatment than your 401(k). The trade-off is real, because money spent on today's bills is money that stops growing.

There is no deadline for reimbursing yourself. If you pay a $2,000 medical bill out of pocket in 2026 and keep the receipt, you can reimburse yourself from the HSA in 2046, tax free, as long as the expense was incurred after the account was opened.

That means twenty years of untaxed growth on money you could have withdrawn immediately, and then a tax-free withdrawal at the end. It requires keeping records for decades, which is the entire cost.

Before 65, a non-medical withdrawal is taxed as income and penalized 20%, which is double the 401(k) penalty and a real deterrent.

At 65 the penalty disappears. Non-medical withdrawals become ordinary income, exactly like a traditional IRA, while medical withdrawals remain tax free. In effect the account turns into a traditional IRA with a tax-free medical option layered on top.

One rule to know at that point: once you enroll in Medicare you can no longer contribute, though you can still spend the balance. People planning to work past 65 often need to stop contributions several months before enrolling, because Medicare Part A can be backdated.

Broader than most people assume. Deductibles, copays, prescriptions, dental, vision, mental health care, physical therapy, and many over-the-counter items all qualify. Insurance premiums generally do not, with exceptions including COBRA, long-term care premiums and, once you are on Medicare, most Medicare premiums.

IRS Publication 502 has the authoritative list, and it is worth reading once because the boundaries are not obvious.

You can only contribute while covered by a qualifying high-deductible health plan, and that plan is not right for everyone. Someone with high, predictable medical costs may be better off with richer coverage even after accounting for the tax break. The account is excellent; the insurance requirement attached to it is a genuine trade-off, covered on the HSA eligibility rules page.

2026 contribution and plan limits are from IRS Revenue Procedure 2025-19. Account rules are in IRS Publication 969, and qualified expenses in Publication 502. Walnut is informational and is not an investment adviser. This guide is educational and not personalized tax or investment advice; anything with a tax consequence is worth confirming with a tax professional.