Are HSA Distributions Taxable? Penalty, Exceptions, and Age 65

HSA distributions are taxable whenever you use the money for something other than a qualified medical expense. Withdrawals that pay for qualifying care come out completely tax-free at any age. Everything else gets added to your ordinary income, and if you’re under 65, the IRS tacks on a 20% penalty on top of the income tax.¹

What Makes a Distribution Tax-Free

The IRS treats a distribution as tax-free when it pays for the diagnosis, treatment, or prevention of disease, or for something that affects a structure or function of the body.² Doctor visits, surgeries, prescriptions, lab work, mental health care, dental cleanings, eyeglasses, and medical transportation all fit. Since the CARES Act, over-the-counter medications and menstrual care products qualify too, with no prescription required.³

The care can be for you, your spouse, or anyone who qualifies as your dependent. You don’t have to actually claim the dependent on your return, as long as they meet the relationship and support tests.⁴

One timing rule catches people off guard: the expense must have been incurred after you opened the HSA. A surgery bill from two years before you established the account cannot be reimbursed tax-free, no matter how legitimate the charge was. The flip side is more forgiving. There is no deadline for reimbursing yourself for expenses incurred after the HSA existed. You can pay a bill out of pocket today, let the account grow for a decade, and reimburse yourself tax-free later. The only requirement is that you kept the receipt.

Insurance Premiums That Qualify

Most health insurance premiums are not qualified expenses, so paying your regular monthly premium from an HSA will normally be taxable. Four narrow exceptions let you use HSA funds tax-free for premiums:⁴

COBRA continuation coverage after leaving a job.
Health coverage paid while you are receiving unemployment compensation under federal or state law.
Long-term care insurance, deductible up to age-based annual limits the IRS updates each year.
Medicare Part B, Part D, and Medicare Advantage premiums once you turn 65. Medigap (Medicare supplement) premiums do not qualify.

If your Part B premium is deducted directly from your Social Security check, you can still reimburse yourself tax-free from the HSA for those amounts, as long as you were 65 or older when the premium was paid.

When a Withdrawal Becomes Taxable

Anything outside the qualified medical definition is taxed as ordinary income. Rent, groceries, travel, and car payments are the obvious triggers. Several gray areas cause more trouble.

Gym memberships and general wellness programs don’t qualify unless a physician prescribes them to treat a diagnosed condition. Weight loss programs work the same way. Cosmetic procedures are excluded unless the surgery corrects a congenital abnormality, an accidental injury, or a disfiguring disease.⁵ Breast reconstruction after cancer treatment qualifies. An elective facelift does not.

The pre-account timing rule is the other easy trap. Opening your HSA in March and reimbursing yourself for a January dental bill is a non-qualified distribution. The IRS treats it the same as if you had spent the money on a vacation.

The 20% Penalty and Its Three Exceptions

A non-qualified distribution gets hit twice. The full amount is added to your gross income and taxed at your marginal federal rate, which runs from 10% to 37% for 2026.⁶ Then the IRS imposes an additional 20% penalty on the taxable portion.¹ Someone in the 22% bracket who takes a $5,000 non-qualified withdrawal owes $1,100 in income tax plus a $1,000 penalty. That’s $2,100 lost from a $5,000 withdrawal.

Three situations remove the 20% penalty entirely, though ordinary income tax may still apply:

Reaching age 65. After that birthday, any withdrawal escapes the penalty. Non-medical withdrawals are still taxed as ordinary income.¹
Disability. The penalty is waived if you are unable to engage in any substantial gainful activity because of a physical or mental impairment expected to result in death or last indefinitely.⁷
Death. Distributions made after the account holder dies are not subject to the penalty.

The disability standard is strict. A temporary injury that puts you out of work for a few months is not enough. The impairment has to be severe enough to prevent any substantial work and must be medically documented as long-term or permanent.

What Changes at Age 65

Age 65 is the dividing line for the penalty. Before then, non-medical withdrawals are taxed and penalized. After then, the penalty disappears and the HSA works much like a traditional retirement account: qualified medical withdrawals stay completely tax-free, and everything else is taxed as ordinary income with no additional 20%.

Medicare Part B, Part D, and Medicare Advantage premiums count as qualified expenses at that point, so paying them from the HSA is more tax-efficient than pulling the same dollars from a 401(k) or IRA.⁴

What Happens to an HSA When the Owner Dies

The tax outcome depends entirely on who inherits the account. If your spouse is the named beneficiary, the account simply becomes their HSA. They can keep using it tax-free for qualified medical expenses.

A non-spouse beneficiary is treated much worse. The account stops being an HSA on the date of death, and the full fair market value becomes taxable income to the beneficiary in that year.⁴ That taxable amount is reduced by any qualified medical expenses of the deceased that the beneficiary pays within one year of the death. If the estate is the beneficiary, the fair market value is included on the decedent’s final return.

Fixing a Mistaken Distribution

If you withdraw HSA money believing an expense was qualified and later find out it wasn’t, you may be able to put the funds back and avoid both the income tax and the penalty. The IRS allows this when the mistake was due to reasonable cause. You must return the money to the HSA no later than the tax filing deadline (without extensions) for the first year you knew or should have known the distribution was a mistake.⁸

When the correction is done properly, the distribution isn’t included in gross income, the 20% penalty doesn’t apply, and the repayment doesn’t count against your annual contribution limit. Your HSA custodian is not required to accept the return of funds, but most do. If a Form 1099-SA was already filed reporting the distribution, the custodian should issue a corrected form after the repayment.

Reporting HSA Distributions and Keeping Records

After each calendar year, your HSA custodian issues Form 1099-SA showing your total gross distributions. You use that figure to complete Form 8889, which is where you separate the qualified portion from anything taxable.⁹ The results flow to Schedule 1 of your Form 1040, and any 20% additional tax goes on Schedule 2. You must file Form 8889 for any year you took a distribution, even if every dollar was for qualified care and you owe nothing extra. If you and your spouse both have HSAs, each files a separate Form 8889.

The burden of proving that a distribution was qualified sits entirely on you. Keep records showing that each withdrawal paid only for qualified expenses, that the expenses weren’t reimbursed from another source, and that you didn’t also claim them as itemized medical deductions.⁴ You don’t send receipts with your return, but you need them if the IRS audits.

The general rule is to keep tax records at least three years from the date you file. The window stretches to six years if you underreport income by more than 25% of gross income.¹⁰ Because there is no deadline on reimbursing yourself, anyone planning to pull money out years later should hold on to receipts indefinitely. A 2026 bill you plan to reimburse in 2036 has to survive that whole stretch, plus the audit window after you file the return claiming the distribution.

1
Office of the Law Revision Counsel. 26 USC 223 – Health Savings Accounts
2
Office of the Law Revision Counsel. 26 USC 213 – Medical, Dental, Etc., Expenses
3
Internal Revenue Service. IRS Outlines Changes to Health Care Spending Available Under CARES Act
4
Internal Revenue Service. Publication 969 (2025), Health Savings Accounts and Other Tax-Favored Health Plans
5
Internal Revenue Service. Publication 502 (2025), Medical and Dental Expenses
6
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
7
eCFR. 26 CFR 1.72-17 – Special Rules Applicable to Owner-Employees
8
Internal Revenue Service. Instructions for Forms 1099-SA and 5498-SA (12/2026)
9
Internal Revenue Service. Instructions for Form 8889 (2025)
10
Internal Revenue Service. How Long Should I Keep Records