Distribution from a Health Savings Account (HSA)

Distributions for Qualified Expenses
Distributions from an HSA are tax-free (i.e., not taxable as income) if used to pay for qualified medical expenses of the account owner, his or her spouse, or dependents, even if the account owner is not currently eligible to make HSA contributions (e.g., no longer enrolled in a High-Deductible Health Plan or enrolled in Medicare).

Distributions not used for Qualified Expenses
Distributions from an HSA that are not used for qualified medical expenses are includable in gross income and, for applicants under age 65, subject to an additional 10% tax.

Determination of Qualified Medical Expense
The Internal Revenue Service (IRS) determines what medical expenses are “qualified.”  A partial list of qualified expenses can be found in IRS Publication 502 (available at www.irs.gov).  HSA account holders should understand that not every expense they incur may be considered “qualified” by the IRS.  NOTE:  IRS Pub. 502 is primarily used to claim a deduction for medical expenses when a taxpayer itemizes.  There are two discrepancies with this publication that are relevant to HSAs:  (1) Pub. 502 says expenses for insurance are a qualified expense; however, the types of insurance that can be paid tax-free from an HSA is more limited (click on the link to “Qualified Expenses”); (2) Pub. 502 says expenses for over-the-counter medicines and products are not qualified; however, they are qualified expenses for HSAs.

Account holders should maintain sufficient records (i.e., legible paper copies of original receipts) verifying expenses.  The account holder’s HSA Trustee or Custodian makes no judgments on what may or may not be a qualified medical expense.  In addition, employers who make contributions to an employee’s HSA cannot make a qualified medical expense determination.

Using HSA funds to pay for medical expenses incurred before I set up my account
You cannot reimburse qualified medical expenses incurred before your account is established. We recommend you establish your account as soon as possible.

HSA Distributions are Optional
When you incur a qualified medical expense; you are not required to pay the expense with available HSA funds.  You may save the funds in your HSA for future expenses, including saving for medical expenses in your retirement years.

HSA Distributions after Death
When the HSA account owner dies, the HSA becomes the property of the named beneficiary.  If the spouse is the beneficiary, he or she becomes the owner of the account and may continue to use the HSA as their own (i.e., pay for qualified expenses tax-free).

If any other person (or entity) is the named beneficiary, the HSA ceases to be an HSA as of the date of the account owner’s death.  However, the beneficiary may continue to pay (tax-free) qualified expenses incurred by the deceased account holder, if paid within one year of their death.  Any remaining funds become part of the deceased account holder’s estate and subject to any applicable taxes upon transfer of ownership of the estate assets.

What information must be reported?
HSA Reporting requirements are straightforward.  Form 1099-SA reports the total distributions taken from the account during the year. Both the form and instructions for completing the form are available from the IRS or can be downloaded from the Treasury and IRS web sites.