HSA Withdrawal Rules

Health Savings Accounts (HSAs) offer a tax-advantaged way to save for medical expenses. However, understanding the withdrawal rules is crucial to maximizing their benefits. An HSA allows you to set aside pre-tax dollars for qualified medical expenses, providing a financial cushion for healthcare costs. However, to fully leverage this tool, you must know when and how to withdraw funds without incurring penalties or taxes.

A financial advisor can help you create a streamlined plan for your HSA funds.

What Is a Health Savings Account (HSA)?

A Health Savings Account (HSA) helps you save on medical costs. Although these funds generally do not cover health insurance premiums, most other medical-related expenses are allowed.

The catch with an HSA is that you can’t open this account unless you have a high-deductible health plan (HDHP). Most HDHPs only provide a small amount of coverage until you meet your deductible.

When you have an HDHP, an HSA is a tax-savvy way to save for potential medical expenses.

HSA Withdrawal Rules

You may withdraw funds from your HSA at any time for any reason. However, if you aren’t using the funds for a qualified medical expense, you must pay a penalty tax. 

These are the intricacies of HSA withdrawal rules.

Qualified Medical Expenses

You can withdraw funds from your HSA at any time to cover qualified medical expenses. The amount you can withdraw in a given year varies based on your medical costs.

An HSA withdrawal is one of three tax advantages offered through this account. When you withdraw funds from your HSA for any qualified medical expense, no taxes are due.

Other Distributions

Unfortunately, life doesn’t always go as planned.

You may need to withdraw from your HSA for a non-qualified medical expense, but there’s a penalty to consider. Any HSA withdrawal you make without a qualified medical expense will be subject to income taxes, plus an additional 20% tax on the withdrawal ¹ .

The taxes you pay on an unqualified HSA withdrawal can add up quickly. Therefore, it’s typically best to avoid HSA withdrawals for any reason other than a qualified medical expense. 

There are a few exceptions to this rule, however.

What If I’m Retired?

HSA withdrawal rules change a bit when you turn 65.

At that point, you can withdraw funds from your HSA without an extra penalty, even if you don’t use the funds for a qualified medical expense. You will still have to pay taxes on withdrawals made for something other than a qualified medical expense. When you make a withdrawal from an HSA, the funds will count towards your income for the year. With that, you’ll just pay regular taxes on the withdrawals.

The same rules apply if you become disabled. You can withdraw the funds without an extra penalty. Keep in mind, however, you’ll still owe income tax on withdrawals for anything other than a qualified medical expense.

Once Medicare kicks in, you can use it for eligible expenses. This includes Part B premiums and Part D prescription drug coverage. That also includes Medigap supplemental policy premiums, but only for retirees over age 65 with an employer-sponsored health plan. 

Alternatively, HSA funds may partially cover the cost of a long-term, tax-qualified car insurance policy. Or, if you are 65 or older, your funds may go towards non-qualified medical costs. However, this last option forfeits some of your tax advantages.

What If I’m Laid Off?

Usually, you can’t use HSAs for private health insurance premiums. However, you can use them if you are using them to pay for health insurance coverage that is part of an employer-sponsored plan through COBRA.

Your funds may also cover premium costs if you receive unemployment compensation. This works at any age.

What Counts as a Qualified Medical Expense?

No taxes are due for withdrawals made for qualifying medical expenses, including the following:

• Payments made to a doctor, dentist, surgeon, chiropractor, psychiatrist or psychologist
• Physical examinations
• Artificial teeth
• Bandages
• Birth control pills
• Breast pump
• Cost of improvements to your home designed to accommodate a condition
• Contact lenses
• Fertility treatments
• Drug addiction treatments
• Guide dog
• Lead-based paint removal
• Long-term care
• Wheelchair
• Weight-loss programs diagnosed by a physician

Although this is not a comprehensive list, it covers common qualified medical expenses.

If you have questions about a particular medical expense, consider talking to a financial advisor for more clarification.

What Doesn’t Count as a Qualified Medical Expense?

While many medical costs can be covered by Health Savings Accounts (HSAs) or Flexible Spending Accounts (FSAs), not all expenses qualify:

• Childcare
• Controlled substances
• Cosmetic surgery
• Hair removal
• Funeral expenses
• Dancing lessons
• Nutritional supplements
• Household help
• Insurance premiums
• Gym membership dues

Some of the items on this list might seem healthcare-related. However, according to the IRS, these are not qualified medical expenses. If you make a withdrawal from your HSA for any of these expenses, the withdrawal will be subject to income tax, plus an additional 20% tax.

Understanding what doesn’t count as a qualified medical expense can help you avoid unexpected out-of-pocket costs and ensure compliance with IRS regulations.

Using Your HSA as a Long-Term Investment Tool

Most people open an HSA with one goal in mind: covering medical bills as they arise.

This approach works, but it leaves one of the most tax-efficient savings vehicles available largely untapped. For those who can manage current out-of-pocket healthcare costs, an HSA can serve as a powerful long-term investment account.

The tax structure is what makes this worth paying attention to. Your HSA contributions are pre-tax and grow tax-free. Withdrawals for qualified medical expenses are also tax-free. No other account type offers all three advantages at once, and this is what makes the HSA worth treating as more than a healthcare spending account.

Most HSA providers allow you to invest your balance once it crosses a certain threshold, often around $1,000 ² . From that point, the money can be put to work in mutual funds or ETFs rather than sitting in cash, earning minimal interest. Over a long time horizon, that difference in growth can be considerable.

The investment strategy that makes this work is simple. Instead of tapping your HSA every time a medical bill arrives, pay those costs out of pocket and save your receipts.

Timeline Considerations

The IRS places no deadline on when you must reimburse yourself for a qualified expense. This means you can let your balance grow for years and then make a tax-free withdrawal later, using those saved receipts as documentation. Some savers accumulate years’ worth of receipts before making a single withdrawal. This allows their invested balance to compound untouched in the meantime.

After age 65, the account becomes even more flexible. Non-medical withdrawals no longer trigger the 20% penalty at that point. You can then use the funds for general living expenses and simply pay ordinary income tax on those withdrawals, the same treatment you would get from a traditional retirement account.

Medical withdrawals, however, remain tax-free regardless of age. This gives HSAs for retirement a meaningful edge over other savings options when healthcare costs are at their highest.

Bottom Line

Understanding HSA withdrawal rules is crucial for anyone looking to maximize the benefits of their Health Savings Account. These accounts offer a tax-advantaged way to save for medical expenses, but knowing how and when to withdraw funds is key to avoiding unnecessary penalties. By understanding these withdrawal rules, you can make informed decisions that optimize your financial health both now and in the future.

HSA Tips

• An HSA can be a nice addition to your savings plan. But navigating the withdrawal rules is easier with the help of a qualified financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you invest through your HSA, look out for the fees. Don’t let fees limit your HSA’s full potential.

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