Health savings accounts (HSAs) are an excellent vehicle for saving. Contributions are tax-deductible, investment income and appreciation in the account are tax-free, and distributions for qualifying expenses are excluded from taxation (aka, “triple tax benefit”). 

Because of the tax benefits, many who can contribute to the HSA don’t always use it for current health expenses. They instead prefer to maximize their annual contributions and use a long-term investment approach for the funds, “letting it ride” for payment of medical expenses after retirement; or possibly with the intent of passing those tax-free benefits on to their heirs. Unfortunately, these strategies can easily backfire if there isn’t a plan in place should the HSA outlive the owner.

Tax and Penalty for “Non-qualified” Distributions

Non-qualified HSA withdrawals are subject to federal and state income tax to the account owner. And, if the owner is under age 65, an additional 20% penalty tax is assessed. Ouch! 

Tax-free withdrawals from the HSA can be made for non-reimbursed and non-deducted medical, dental, vision, prescription, and hospital expenses incurred after the account was opened. This includes other non-typical expenses such as chiropractic care, fertility treatments, service animals, etc. In addition, HSA reimbursement can be used for qualifying expenses incurred by the account owner, spouse, and their tax dependents. Account owners 65+ can use the HSA to reimburse Medicare Part B, D, and Advantage premiums. Reimbursement for Medigap premiums is subject to taxation.

At age 65, distributions from HSAs for non-qualified expenses are still taxable; however, the 20% tax penalty is not charged.  

Your Beneficiary Matters

It’s important to name a beneficiary of your HSA and periodically review the designation to ensure it remains appropriate, particularly should you experience a life-changing event (i.e., divorce, illness, death of the beneficiary, etc.).

  • If the spouse is the beneficiary, the HSA will remain, and the spouse can use it with the same tax-free benefits. 
  • If the beneficiary is a non-spouse individual, the account loses its HSA status and will be fully disbursed to the beneficiary at the owner’s passing. 100% of the disbursement is taxable to the beneficiary. However, if the beneficiary pays for the account owner’s unpaid HSA-qualified medical bills within one year after the owner’s death, the amount of those expenses is excluded from taxation. The beneficiary mustn’t have anyone else pay for the expenses to get the tax-free reimbursement.
  • If no beneficiary is named, or the beneficiary is the owner’s estate, the HSA must be fully disbursed to the account owner’s estate and will be 100% taxable to the account owner on their final tax return. Even qualifying medical expenses that occurred before death but not reimbursed are subject to taxation.

 “Superfunding” the HSA

Be careful if you’re maximizing your HSA contributions and deferring reimbursements until after retirement. It’s imperative that you keep all receipts from qualifying expenses after opening the account you’ve personally paid and not deducted on Schedule A for taxes. Proof of these expenses allows for a lump, tax-and-penalty-free distribution for the total amount later. You won’t be asked for these receipts when making the withdrawal; however, you must keep them if you get audited by the IRS.

This strategy works nicely should one’s plan for a long, healthy retirement go uninterrupted by a terminal illness or unexpected death. However, if the unfortunate outcome occurs and the account beneficiary is not a spouse, know that the account owner, child, or other beneficiaries will be forced to realize a chunk of taxable income.

Minimizing or Avoiding Forced Distribution

Below are strategies for spending down the HSA if the unexpected occurs:

  • Tally all receipts for non-reimbursed, non-deducted qualifying healthcare costs since the HSA was open and take a lump distribution for the amount. Qualifying expenses not reimbursed before the owner’s death will be 100% taxable to the non-spouse beneficiary when the HSA is disbursed.
  • If the spouse is a beneficiary, consider taking a partial distribution and allow spouse to inherit the balance, just in case spouse cannot use all of the HSA funds before passing.
  • If a child is the beneficiary, withdraw all that you can tax-free, then let the balance pass to the child. Or, if your tax bracket is lower than the beneficiary’s, take full distribution of the account even if there are no qualifying expenses for the tax-free benefit. In this situation, those under age 65 must also consider the 20% penalty tax.
  • As mentioned previously, non-spouse beneficiaries who pay for qualifying expenses of the deceased will not be taxed on that amount when the HSA is disbursed. 


If your health plan qualifies for the HSA, I recommend you take full advantage of its triple tax benefit. If you “superfund” the account with no intention of using it before retirement, keep all receipts from qualifying expenses to enjoy tax-free withdrawals later; and don’t forget to review your beneficiary designation often. Doing these things will provide options for passing on tax-free benefits to heirs if life throws you a curve ball.

Kathy Hower, CFP, is a Senior Wealth Advisor with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at or email Kathy at

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