Understanding the HSA Withdrawal Penalty and Other Useful Information

HSA withdrawal penalty

Health Savings Accounts (HSAs) are a popular tool for saving on taxes while setting aside money for medical and healthcare expenses. When you enroll in a qualified high deductible health plan (HDHP) and sign up for an HSA, you contribute pre-tax money into an account and then withdraw those funds for qualified healthcare expenses (as defined by the IRS). When used for eligible expenses, withdrawals are tax-free.

Many HSA owners ask if they can use the money for non-qualified expenses, and if so, whether they would incur a withdrawal penalty.

First, let’s look at some HSA basics.

HSA Basics

In some ways, an HSA is similar to a Flexible Spending Account (FSA). Each payday you contribute money into the HSA on a pre-tax basis. That means the funds come out of your paycheck before taxes are taken out, which lowers your taxable income and saves you money. Those HSA funds can be spent to cover out-of-pocket healthcare expenses for you and your family. So long as the money is used for qualified expenses, withdrawals are not taxed or penalized.

One distinct advantage with an HSA is that you own the account – just like a checking or savings account; you can keep and use the money even if your employment status changes. In addition, there are several ways to grow the account over your lifetime.

As you build the balance, the money in your HSA earns interest tax-free. You can also invest HSA dollars to help the balance grow and enjoy tax-free investment returns. Plus, an HSA does not have a “use it or lose it” requirement. At the end of the plan year, any remaining account balance rolls over to the following year; you don’t forfeit any unused funds in the account.

With the ability to contribute and grow your HSA, what happens if you use the balance for non-qualified expenses? Believe it or not, your age determines whether or not you will be charged an HSA withdrawal penalty.

Non-qualified expenses and the HSA withdrawal penalty

Using your HSA in retirement – No penalty

One significant perk of an HSA is that once you reach age 65, you can withdraw funds for any expense without penalty. The only caveat is that the withdrawal will be taxed like regular income. If the HSA dollars are spent on eligible expenses, such as Medicare premiums or other healthcare needs, then those withdrawals are not subject to taxes (same as pre-retirement).

With the ability to roll all funds over year after year, contributions to your HSA that exceed qualified healthcare expenses can add up to a tidy sum by the time you retire. In fact, many people with low to moderate healthcare expenses use their HSA as a supplementary retirement account.

Now, if you use the money for non-qualified expenses before age 65, there is a withdrawal penalty.

IRS penalty and taxable income

Prior to age 65, if you use your money for non-qualified expenses, the IRS imposes a hefty HSA withdrawal penalty of 20 percent on the amount withdrawn. For example, if you spend $500 on non-qualified expenses, your penalty will be $100.

Unfortunately, the bad news doesn’t stop there. In addition to the 20 percent penalty, the IRS will also consider any HSA funds spent on non-qualified expenses as taxable income. This means they must be included as part of your total income when filing your taxes, which could increase the amount you owe or reduce any refund you may be entitled to.

Why spend on non-qualified expenses?

People spend HSA funds on non-qualified expenses for many reasons. There are times people need the money to pay for expenses in other areas of their lives. In those cases, they may feel that the need for the extra money outweighs the cost of the penalty and additional taxes.

Other instances could include a common mistake like assuming an expense is qualified when it is not.  It also happens that people accidentally use their HSA card to pay for non-qualified expenses.

To avoid the penalty and tax, double check that an expense is qualified before using HSA funds to pay for it. You can ask your benefits administrator for clarification. For example, most prescription medications are qualified, as are over-the-counter drugs; however, other items do not meet the qualification guidelines published by the IRS. Always save your relevant documents and receipts to verify expenses.

How can I avoid non-qualified expenses?

One way to avoid spending your HSA dollars on non-qualified medical expenses is to check with your HR department or benefits administrator in advance. Learn more about HSA eligible expenses.

In addition, if you are using a HSA debit card, many have security features built in to them:

  1. IIAS:  Many pharmacies, supermarkets, and other approved locations use an inventory control system programmed to know which expenses are eligible and which are not. If you try to purchase an ineligible item, your card may be declined.
  2. MCC:  Merchant category codes identify which locations are approved and which are not. This prevents accidental usage of your card at a restaurant or bus station, for example, when it should be only used at pharmacies, doctor’s offices, etc.

Keep in mind, mistakes can still happen. Depending on your administrator or employer, your HSA card may not have these security features activated; this could result in an accidental ineligible transaction. Be sure to double check which card you pull out of your wallet when you need to make a purchase.

Mistake Forgiveness

The IRS does allow some leeway for honest mistakes. If you can show “clear and convincing” evidence that a non-qualified expense was made by mistake, you are allowed to return the money to your HSA account and avoid the penalty. For example, suppose you assumed a certain healthcare product or medical procedure was qualified and later discovered that it wasn’t. If you can show you made an honest mistake, the IRS will let you return the money to your account.

Again, it’s very important that HSA owners keep all their receipts, whether the purchase is made with a benefits card or by other method. A paper trail helps when filing for reimbursement and helps track purchase details (date/time, amount, location, etc.), in case of IRS audit.

HSA Facts You Should Know

Like many financial accounts, HSAs can seem complex and confusing, especially when opening one for the first time. Fortunately, there are many reliable sources of information online where you can learn more and get your questions answered. Some frequently asked questions include:

Can anyone open an HSA account?

No. HSAs have very specific requirements for eligibility. In addition to being enrolled in a high deductible healthcare plan, you must also:

  • Be age 18 or older
  • Have no other non-HDHP medical coverage
  • Not be enrolled in Medicare
  • Not be claimed as a dependent on someone else’s tax returns

Can other people contribute to my HSA?

Yes, others may contribute to your HSA so long as you meet the enrollment qualifications. Many employers offer contributions as part of their benefits package. You could also receive contributions made on your behalf by family members or others. The total combined contribution amount (your contributions plus others) all count toward the annual limit.

2020/2021 HSA Annual Contribution Limits

2021 Annual Contribution Limits2020 Annual Contribution Limits
Self-Only Coverage$3,600 (+ $50)$3,550
Family Coverage$7,200 (+ $100)$7,100
Catch up ContributionsLimit + $1,000Limit + $1,000

If I change jobs, will I lose my HSA account?

No. Unlike FSAs, your HSA stays with you for life unless you choose to close it. This is true whether the account is sponsored by your employer or you opened it on your own. This is one of the features that makes HSAs an effective tool for saving, investing, and adding to your retirement nest egg.

Is there a time limit on submitting a claim for reimbursement?

No. There is no hard time limit. The only requirement is that the eligible expense happened after you opened the account. Then you can submit a reimbursement claim at a later date (even months or years later). For instance, if you opened the HSA in January 2018, any eligible expense after that open date can be reimbursed years later (like in 2020 or 2021). You could not file a claim for an expense prior to the January 2018 open date.


HSAs are one of the best financial tools for managing healthcare expenses. They also provide a unique opportunity to add to your retirement savings or even save for other expenses. Understand the rules governing HSAs, use your funds wisely and you can enjoy the many benefits they have to offer without any penalties.

DataPath, Inc. creates flexible, cloud-based HSA management software solutions.

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