Distribution of Funds From an HSA
Distributions for Qualified Expenses
When distributions from a Health Savings Account (HSA) are used to pay for qualified medical expenses of the account owner, his or her spouse, or dependents, the distributions are excluded from gross income -- even if the individual is not currently eligible to make HSA contributions. Even if he does not itemize his deductions on his federal income taxes, he may deduct his contributions to an HSA.
Distributions not used for Qualified Expenses
Distributions not used for qualified medical expenses are includable in gross income and, for applicants under age 65, subject to an additional 10% tax.
For Ineligible Individuals
If the Health Savings Account (HSA) beneficiary is no longer "eligible" (e.g., over age 65, entitled to Medicare or no longer enrolled in a High-Deductible Health Plan (HDHP), distributions used to pay qualified medical expense continue to be exempt from gross income.
Determination of Qualified Medical Expense
The person who establishes an HSA makes the qualified medical expense determination and should maintain verifying expense records. The HSA Trustee or Custodian makes no judgments on what may or may not be a qualified medical expense. They simply accept the judgment of the HSA owner.
In addition, employers who make contributions to an employee's HSA cannot make a qualified medical expense determination. Determining qualified medical expense is always the job of the HSA owner.
HSA Disbursements for "Old" Expenses
The HSA account must be established before the date of the medical claim which is to be paid or reimbursed from the account. However, there is no tax code rule preventing a custodian, trustee, HSA administrator or insurer from making your Health Saving Account effective date back to the date you are first eligible (i.e., the first day of the first full month the HSA high deductible health plan is in effect). This is the date from which the maximum allowable contribution is calculated, and is the date when allowable withdrawals can begin.
When you incur a qualified medical expense, you are not obligated to pay the expense with available Health Savings Account (HSA) funds. You face a trade-off: You can spend after-tax income (not good), in return maximizing the long-term savings in your HSA (good).
Financial professionals advise, in most circumstances, using your HSA funds to pay necessary qualified medical expenses. Keep in mind, if HSA funds are not used to pay qualified medical expenses, those HSA funds will eventually be subject to income tax.
HSA Distributions after Death
If the Health Savings Account (HSA) owner dies, the HSA becomes the property of the named beneficiary. If the spouse is the beneficiary, the surviving spouse is subject to income tax only on HSA distributions not used for qualified medical expenses.
If the HSA passes to a person other than the spouse, the HSA terminates as of the date of death, and the person is required to include in gross income the assets of the HSA at the date of death. The taxable amount is reduced by any HSA payments for the decedent's qualified medical expenses, if paid within one year after death.
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