Can I Cash Out My HSA? Rules, Taxes, and the 20% Penalty

You can cash out an HSA whenever you want — the money is yours — but the tax bill depends on what you spend it on and how old you are. Withdrawals for qualified medical expenses are tax-free at any age. Non-medical withdrawals before age 65 are taxed as ordinary income and hit with an additional 20% tax. After 65, that 20% goes away and non-medical withdrawals are simply taxed as income.¹

What a Non-Medical Withdrawal Costs Before 65

Pulling money out for anything other than qualified medical expenses before you turn 65 is the most expensive way to use an HSA. The IRS adds the withdrawal to your taxable income for the year, so it’s taxed at your marginal rate — anywhere from 10% to 37% for 2026.² On top of that, the IRS charges a 20% additional tax on the non-medical portion.¹

A quick example. Say you take out $5,000 to pay for a vacation and you’re in the 22% bracket. You’d owe $1,100 in federal income tax plus $1,000 in the additional tax. That’s $2,100 gone from a $5,000 withdrawal, before any state tax. At higher brackets the combined hit approaches half of what you took out.

You can also close the account entirely and take the balance as a lump sum. Same rules apply — every dollar not spent on qualified medical care is taxable, and the 20% add-on applies if you’re under 65. Some providers charge a closure or transfer fee, often $20 to $50.

Three Situations That Eliminate the 20% Penalty

The additional 20% tax disappears in three cases: you turn 65, you become disabled, or you die.¹ Income tax on non-medical withdrawals still applies in the first two situations. The penalty exception is not a tax exemption.

Age 65

Once you hit 65, non-medical withdrawals are taxed as ordinary income and nothing more. The account effectively behaves like a traditional IRA at that point.³ Qualified medical withdrawals stay completely tax-free, so there is still real value in directing the money toward healthcare when you can.

Disability

If you become disabled before 65, the 20% is waived. Federal law defines this as being unable to engage in any substantial gainful activity because of a physical or mental condition expected to result in death or to be long-lasting and indefinite.⁴ Income tax on the non-medical portion still applies.

Death

The penalty does not apply at death, but what happens next depends on who you named as beneficiary. A surviving spouse who inherits the HSA takes it over as their own, and it keeps its full tax-advantaged status. A non-spouse beneficiary loses the HSA wrapper entirely — the fair market value on the date of death becomes taxable income to that beneficiary in the year you die, though it can be reduced by any of your qualified medical expenses the beneficiary pays within one year of the date of death. If your estate is the beneficiary, the fair market value goes on your final income tax return.¹ Naming a spouse rather than an estate or another individual generally preserves the most value.

What Still Comes Out Tax-Free

Qualified medical expenses are broadly defined and cover far more than hospital bills. Prescription drugs and insulin qualify (insulin is covered even without a prescription).⁵ So do dental work (cleanings, fillings, root canals, braces, dentures), vision care (exams, glasses, contacts), mental health services including therapy and substance abuse treatment, qualified long-term care services, and menstrual care products.¹

Your HSA can also pay for your spouse’s and dependents’ medical costs tax-free, and for anyone you could have claimed as a dependent except that they filed a joint return, had income above the exemption threshold, or you could be claimed on someone else’s return.¹ Those people don’t need to be on your high-deductible plan; they just need to have incurred a qualifying expense.

Reimburse Yourself Years Later

There is no deadline to reimburse yourself for a qualified medical expense. You can pay a medical bill out of pocket today, leave your HSA invested for a decade, and then pull the money out tax-free to reimburse yourself for that old expense. The only requirement is that the expense was incurred after you established the HSA.¹ To use this, keep dated records of every out-of-pocket medical expense — provider, treatment, and amount — because you have to be able to prove the expense if audited later.

Expenses That Will Trigger the Tax and Penalty

Some healthcare-adjacent costs look like they should qualify but don’t. Spending HSA funds on them is treated exactly like any other non-medical withdrawal. Watch out for:

Cosmetic procedures such as face lifts, hair transplants, liposuction, teeth whitening, and electrolysis, unless the procedure corrects a deformity from a congenital condition, accident, or disfiguring disease⁶
General health activities like gym memberships, dancing lessons, and swimming lessons, even when a doctor recommends them⁶
Marijuana and other substances that remain illegal under federal law, regardless of state legalization⁶
General vitamins and nutritional supplements not prescribed for a specific medical condition
Childcare and funeral costs, which are never treated as medical expenses⁶

How to Actually Take the Money Out

Most HSA providers give you several ways to access funds. Many issue a debit card tied to the account, which you can use at a pharmacy, doctor’s office, or an online retailer that sells eligible items. Most also let you request an electronic transfer to a linked bank account through their online portal, typically processed in a few business days. Some still send paper checks on request, though that takes longer.

If your goal is to move the balance to a different HSA provider rather than spend it, use a trustee-to-trustee transfer. The funds go directly from one custodian to another, so it isn’t a distribution and has no tax consequences. A do-it-yourself rollover, where you withdraw the money and redeposit it into a new HSA within 60 days, is also allowed but only once every 12 months.¹

Reporting the Withdrawal and Keeping Records

Every year you take a distribution, your HSA custodian sends you Form 1099-SA showing the total amount withdrawn. You report your HSA activity on Form 8889, which is filed with your Form 1040. You must file Form 8889 in any year you took a distribution, even if every dollar went to qualified medical expenses.³

Your custodian does not check whether your withdrawals were actually for qualified medical care. That’s on you. Keep itemized receipts, Explanation of Benefits statements from your insurer, and documentation showing the date, nature, and cost of each service. If the IRS audits and you can’t prove a withdrawal was for a qualifying expense, the agency can reclassify it as non-medical and assess income tax plus the 20% additional tax.

Dividing an HSA in a Divorce

An HSA balance split under a divorce or separation agreement is not a taxable event. After the transfer, the receiving ex-spouse is treated as the account holder for their portion, and the funds keep their HSA status.⁴ The transfer has to be made under a divorce or separation instrument. An informal agreement between spouses to split the balance would not get tax-free treatment.

1
Internal Revenue Service. Publication 969 (2025), Health Savings Accounts and Other Tax-Favored Health Plans
2
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
3
Internal Revenue Service. Instructions for Form 8889 (2025)
4
Office of the Law Revision Counsel. 26 USC 223 – Health Savings Accounts
5
Office of the Law Revision Counsel. 26 USC 213 – Medical, Dental, Etc., Expenses
6
Internal Revenue Service. Publication 502 (2025), Medical and Dental Expenses