Understanding the HSA Withdrawal Penalty and Other Useful Information

HSA withdrawal penalty

Health Savings Accounts (HSAs) are a wonderful tool for saving money on 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 – up to $3,500 for individuals and up to $7,000 for families in 2019 – then withdraw those funds for qualified healthcare expenses (as defined by the IRS). When used for qualified expenses, withdrawals are tax-free. However, many HSA owners wonder if the money can be used for non-qualified expenses. If so, is there an HSA withdrawal penalty?

First, let’s look at some HSA basics.

HSA Basics

In some ways, an HSA is very similar to a Flexible Spending Account (FSA). As mentioned above, each payday you contribute money into the Health Savings Account on a pre-tax basis. That means the funds come out of your paycheck before taxes are taken out, thereby lowering your taxable income and saving you money. You then use the money in the HSA to cover out-of-pocket healthcare expenses for you and your family, and you don’t have to pay taxes so long as the money is used for qualified expenses.

HSAs do not have a “use it or lose it” requirement, unlike an FSA. At the end of the plan year, all remaining HSA dollars roll over to the following year; you don’t forfeit any unused funds in the account.

Another huge advantage is that the money in your HSA earns interest tax-free. You can also invest your HSA dollars to help the balance grow and enjoy tax-free investment returns.

Non-qualified expenses and an HSA withdrawal penalty

If you are unfamiliar with HSAs, this may sound too good to be true. In fact, you may be wondering, is there an HSA withdrawal penalty? The answer is yes, but only if you use the money for non-qualified expenses before retirement age.

IRS Penalty and taxable income

If you use your funds for non-qualified expenses, the IRS imposes a HSA withdrawal penalty of 20 percent on the amount. 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 also considers 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. One common mistake is that people assume an expense is qualified when it is not.  It also happens that people accidentally pay for non-qualified expenses with their HSA debit cards. Other times people need the money to pay for unexpected expenses in other areas of their lives. In those cases, the need for the money outweighs the cost of the penalty and additional taxes.

To avoid the penalty and tax, always check to make sure an expense is qualified before using HSA funds to pay for it. For example, most prescription medications are considered qualified, whereas over-the-counter drugs are not unless you have a prescription for them. If you have a prescription for an OTC medical product, save it and the receipt to verify the eligibility of the medicine.

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 contact your benefits administrator. Learn more about HSA eligible expenses.

In addition, if you have an HSA debit card, many cards have security features built in to them:

  1. IIAS: Inventory code in many pharmacies, supermarkets, and other approved locations that is 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 are used to identify which locations are approved and which are not. This prevents accidental usage of your card at a restaurant or bus station, when it should be only used at pharmacies, grocery stores, etc.

Keep in mind, mistakes can still happen. Depending on your administrator or employer, your card may not have these security features activated, and you may accidentally purchase take out with your HSA card instead of your bank card. 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 with no penalty. For example, suppose you assumed a certain healthcare product or medical procedure was qualified and it wasn’t. If you can show you made an honest mistake, the IRS will let you return the money.

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 you track the purchase details (date/time, amount, location, etc.), in case of IRS audit.

HSA Facts You Should Know

Like many financial products, HSAs can seem complex and confusing, especially when opening one for the first time. Fortunately, there are many good sources of information online where you can learn more about these accounts and get your questions answered. Some of the most commonly 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 (HDHP), you must also:

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

What happens to my HSA when I retire?

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

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

Can other people contribute to my HSA?

Yes. In addition to you and your employer, contributions can be made by any other person on your behalf, including family members. Contributions to your HSA may be made so long as you meet the enrollment qualifications.

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

No. Unlike FSAs, your HSA stays with you for life unless you decide to close it. This is true whether your HSA 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.


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. is a leading provider of cloud-based, all-in-one HSA solutions.

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