Certified Plan Sponsor Professional (CPSP) Practice Exam

What are the tax benefits of a Health Savings Account (HSA) when used for qualified medical expenses?

1. Earnings grow tax-free, withdrawals are subject to federal income taxes

2. Contributions are subject to state income taxes

3. Earnings grow tax-free, contributions are exempt from federal income taxes, and withdrawals are tax-free

4. Only contributions are tax-exempt

The correct answer is: Earnings grow tax-free, contributions are exempt from federal income taxes, and withdrawals are tax-free

A Health Savings Account (HSA) offers multiple tax advantages when used for qualified medical expenses, making it an attractive option for individuals looking to manage their healthcare costs. The correct understanding of these benefits includes that contributions made to an HSA are tax-exempt, meaning they can be deducted from your taxable income, thereby reducing your overall tax liability for the year in which you make the contributions. Moreover, the earnings on the funds within an HSA grow tax-free. This means that any interest or investment gains added to the account are not subject to federal income taxes as long as the funds remain in the HSA. When these funds are finally used for qualified medical expenses, which include a wide range of healthcare services and products, withdrawals are also tax-free. This triple tax benefit is a unique feature of HSAs, as few tax-advantaged accounts offer similar terms. In contrast, other choices do not encapsulate the comprehensive tax advantages associated with HSAs. For example, one option incorrectly states that withdrawals are subject to federal income taxes, while another implies that contributions are subject to state income taxes, which is not universally applicable as many states follow federal guidelines. Another choice incorrectly limits the tax benefits to only contributions being tax-exempt, failing to account