Health Savings Account (HSA) – Withdrawal and Spending Rules
A health savings account (HSA) is a trust or account used to pay medical expenses that a high deductible health plan (HDHP) does not pay. HSAs offer triple tax advantages to account owners, including tax exemptions for contributions, earnings, and distributions. To obtain the last exemption, HSA holders must follow strict rules for spending HSA funds.
HSA funds may be used on a tax-free basis if they are used to pay for qualified medical expenses that were incurred after the HSA was established. Individuals do not need to meet the eligibility criteria for making HSA contributions to receive a tax-free withdrawal from their HSAs. For medical expenses incurred after an HSA is established, there is no time limit for when an HSA owner may take a withdrawal. All unused funds remain in an HSA from year to year and may be used for qualified medical expenses incurred in the future.
Employers that offer HSA programs generally have very little, if any, involvement in HSA distributions. HSA owners have sole discretion for how and when to use HSA funds, and an HSA custodian or trustee tracks and reports all HSA activity.
Withdrawal Timing
• HSA funds cannot be used for expenses incurred prior to the date the HSA was established.
• For medical expenses incurred after an HSA is established, there is no time limit for when an HSA owner may take a withdrawal.
• HSA owners do not have to be eligible for HSA contributions in order to take a tax-free withdrawal.
Eligible Medical Expenses
• HSA withdrawals are tax-free if they are used for qualified medical expenses that are not paid or reimbursed by another source.
• Health insurance premiums are not qualified medical expenses, with some limited exceptions.
• Over-the-counter (OTC) medicines and drugs and menstrual care products are qualified medical expenses.
When May HSA Withdrawals Occur?
HSA funds cannot be used for expenses incurred prior to the date the HSA was established. In other words, a withdrawal is taxable (and possibly subject to the 20% penalty) if the HSA owner uses it to pay for medical care that was obtained before the HSA existed. State law determines the exact HSA establishment date for this purpose.
For medical expenses incurred after an HSA is established, there is no time limit for when an HSA owner may take a withdrawal. Similarly, HSA owners are not obligated to take distributions at any time. All unused funds remain in an HSA from year to year and may be used for qualified medical expenses incurred in the future.
Even if an HSA owner becomes ineligible to make (or receive) HSA contributions, he or she may still use tax-free distributions from an existing HSA to pay qualified medical expenses at any time, as long as the expenses were incurred after the HSA establishment date. For example, an HSA owner who only qualifies to have contributions made into an HSA in Year 1 may still use the HSA funds to pay qualified medical expenses that are incurred in Year 2 or later.
In addition, the money used to pay a qualified medical expense does not have to be in the HSA at the time the expense is incurred. For example, if an existing HSA has $1,000 and the HSA owner incurs $3,000 in medical expenses that year, he or she can pay the first $1,000 from the current HSA funds and then wait for future HSA contributions to pay or reimburse him- or herself for the remaining $2,000.
This Compliance Overview is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel for legal advice. ©2015-2017, 2019-2020, 2023 Zywave, Inc. All rights reserved.
