Health Savings Accounts (HSAs) are a special type of account that allows you to save for medical expenses tax-free. Contributions can be deducted on your taxes (up to a limit, of course) and withdrawals from the account for “qualifying medical expenses” are not included in taxable income for that year.

The list of qualifying expenses is extensive, covering prescription drugs (and insulin even though not prescribed), dental treatment, contact lenses and eyeglasses, eye exams, hearing aids, health insurance premiums for which you are not claiming another credit or deduction, and more.

Since everyone is likely to have some sort of medical expenses eventually and an HSA makes money saved for those expenses entirely non-taxable, HSAs are a smart choice if they are available. There are some factors that limit their potential, but they are still beneficial for many people.

For those with HSAs, it is generally a good idea to contribute the maximum each year. In 2017, the contribution limit for single coverage is $3,400. For family coverage, the limit is $6,750. Unfortunately, there is a catch.

The amount you can contribute is reduced proportionately to the number of months in the year during which you were eligible for the High-Deductible Health Plan (HDHP) that accompanies your HSA. If you were only eligible for six months, you can only contribute half of the normal limit.

However, there is a second rule governing contribution limits called the “last-month rule.” If you are eligible for a High-Deductible Health Plan on December 1, you are allowed to contribute to the HSA as though you had been eligible for the whole year assuming you must remain eligible for a “testing period” of a full calendar year. This means you must keep the High-Deductible Health Plan for the full upcoming year. If you don’t, the extra amount you contributed because of the last-month rule becomes taxable income and you have to pay an additional 10% penalty. The penalty is waived if the reason your ineligibility was due to death or becoming disabled.

The potential growth for early investment should not be overlooked.

There is worth in saving for your own health care without being burdened by any taxation. If an HSA-compatible plan would benefit you, it would be a tragedy to fail to contribute as much as you can just because of the confusing rules governing contributions. Understanding that the general partial-year eligibility rules may not apply to you could save you thousands in the short-term and gain you far more than thousands in the long-term.

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