An HSA works similarly to a retirement account, but comes with unique tax advantages not available with other plans.

To compare, let’s also look at the traditional and Roth IRA.

  • With a traditional IRA, you make contributions with pre-tax income, but you have to pay ordinary income taxes when you make withdrawals in retirement.
  • With a Roth IRA, you make contributions with post-tax income so that you can enjoy tax-free withdrawals in retirement.
  • With an HSA, contributions are made with pre-tax income, like a traditional IRA. However, withdrawals are also tax-free if you use it to pay for qualified medical expenses. You only have to pay taxes on withdrawals if you withdraw early (before the age of 65), or use your withdrawn funds for anything other than qualified medical expenses.
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HSA withdrawal rules

Qualified withdrawals

You can make tax-free withdrawals from your HSA at any age to pay for qualified medical expenses.

Nonqualified withdrawals

If you withdraw the funds and don’t use it for qualified medical expenses, there is a 20% penalty plus income taxes on the amount drawn.

Withdrawals after the age of 65

Once you reach the age of 65, you can start to make withdrawals from your HSA without having to use it for qualified medical expenses. The withdrawn amount will be taxed as ordinary income.

What counts as a qualified medical expense?

The good news is that most medical expenses are qualified to be paid for by your HSA including:

  • Doctor appointments, surgeries, and prescriptions.
  • Dental treatments and braces.
  • Eye exams, glasses, and contact lenses.
  • Visits to a psychiatrist or psychologist.
  • First aid supplies and medical equipment, such as bandages, ointments, wheelchairs, and crutches.
  • Health monitoring supplies, like blood pressure cuffs and glucometers.
  • Feminine hygiene products, like tampons and pads.
  • Complimentary treatments, such as massages, acupuncture, and chiropractor visits.
  • Drug addiction treatments.
  • Fertility and maternity services, like IVF and breast pumps.
  • Medical expenses for your children and other qualified dependents, even if they’re not on your health plan.
  • Home improvement costs to accommodate a certain medical condition.

This is not a full list. Check with your financial planner if you’re unsure if a medical expense is qualified.

When should I withdraw from my HSA?

An HSA should be viewed as a long-term investment vehicle. At the end of the day, an HSA should be viewed as a retirement plan with a tax-free option to withdraw the funds if you need it to pay your medical bills.

If you’re under the age of 65, withdrawals should be avoided for any non-qualified medical expenses since you’ll have to pay a hefty penalty of 20% on the withdrawn amount (in addition to income taxes).

An HSA gives you triple tax advantages. Not only do you get a tax-deduction on your contribution, you also get to keep your money compounding tax-free. Put another way, your contributions can grow into a larger balance and help you pay for heftier medical bills, if needed. If the funds end up being unused, you can start taking distributions from your account for any reason once you reach the age of 65. You’ll have to pay ordinary income taxes, but you won’t be hit with the 20% penalty.