How to Access Your HSA Funds and Avoid the 20% Penalty

To use HSA funds, you pay for a qualified medical expense in one of three ways: swipe the debit card your custodian issued you, send payment through the custodian’s online bill pay, or pay out of pocket and later reimburse yourself by transfer from the account. Withdrawals for qualified medical expenses are free of federal income tax at any age. Anything else, before age 65, is taxed as ordinary income and hit with an additional 20% penalty. The account is yours, not your employer’s, so the balance rolls over each year and follows you between jobs.

What Counts as a Qualified Medical Expense

The tax code defines qualified medical expenses broadly as costs for diagnosing, treating, or preventing disease, plus anything that affects a structure or function of the body.¹ In practice, that covers most of what you’d expect from a health provider and quite a bit that people don’t realize qualifies.

Doctor and specialist visits, surgeries, hospital stays, and mental health services
Prescription medications, and insulin whether or not it requires a prescription
Over-the-counter medications such as pain relievers, allergy medicine, and cold remedies, with no prescription needed²
Menstrual care products including tampons, pads, liners, and cups²
Dental care including cleanings, fillings, braces, and oral surgery
Vision care including eye exams, glasses, contact lenses, and corrective surgery
Medical equipment such as crutches, hearing aids, wheelchairs, and blood sugar monitors
Lab work, X-rays, physical therapy, and chiropractic care

You can also spend HSA funds on qualified expenses for your spouse and tax dependents, even if they’re covered under a different insurance plan.³ Married couples cannot open a joint HSA, but either spouse can use their own account to pay the other’s eligible bills.

Health Insurance Premiums Usually Do Not Qualify

As a general rule, insurance premiums are not a qualified HSA expense. The tax code carves out four exceptions:²

COBRA continuation coverage after leaving a job
Health coverage during any period you receive federal or state unemployment benefits
Qualified long-term care insurance premiums
Medicare Part A, Part B, Part D, and Medicare Advantage premiums once you are 65 or older, but not Medigap supplemental policies⁴

Using HSA money for any other premium is treated like any non-qualified withdrawal: ordinary income tax, and the 20% penalty if you’re under 65.

The Three Ways to Pay

Debit Card

Most custodians issue a debit card tied directly to the account. Swipe or tap it at the provider’s office, pharmacy, or hospital, and the payment pulls from your HSA balance immediately. Nothing else changes hands, and the charge shows up on your monthly statement. It’s the simplest option because you never front the money.

Online Bill Pay

When a bill comes by mail or through a patient portal, log into your custodian’s platform and pay it from there. You enter the provider’s name and address and the invoice amount, and the custodian sends either an electronic payment or a paper check. Most platforms give you a confirmation number for tracking.

Pay Out of Pocket, Reimburse Yourself Later

You can also pay a medical bill with a personal card or check and then move HSA funds into your checking account to cover it. Link a personal account to your HSA online, request an ACH transfer for the exact amount you spent, and the money usually lands in two to five business days.

There is no federal deadline for reimbursement. As long as the expense was incurred after your HSA was established, you can wait months or years to pull the money out.² That delay lets the balance stay invested and grow tax-free in the meantime. The one hard limit: expenses from before the account existed never qualify, no matter when you withdraw.⁴ State law determines the date an HSA is officially established.

Keep Your Receipts

You don’t submit receipts when you take a distribution, but the IRS can audit the account and ask you to prove each withdrawal covered a qualified expense. For every payment, hold onto records showing the date of service, the provider’s name, a description of the expense, the amount charged, and evidence that insurance did not already reimburse the cost.⁵ Explanation of Benefits statements from your insurer are useful for showing what portion of a bill was left to you.

Keep the records for at least three years after you file the return that reports the withdrawal.⁶ If you use the delayed-reimbursement approach, that clock doesn’t start until the year you actually take the money out, so in practice you keep those receipts indefinitely until you reimburse yourself.

Non-Medical Withdrawals and the 20% Penalty

Pull HSA funds for anything other than a qualified medical expense and the amount goes into your gross income for the year plus a 20% additional tax.² A $1,000 non-qualified withdrawal costs $200 in penalty alone, on top of whatever you owe in income tax on the $1,000.

The 20% penalty does not apply if you are 65 or older, disabled, or if the distribution occurs after the account holder’s death.⁴ Qualified medical withdrawals stay tax-free at any age.

How Using the HSA Changes at 65

Two things shift at age 65. The 20% penalty on non-medical withdrawals goes away, so you can spend the money on anything, though non-medical withdrawals are still taxed as ordinary income much like a traditional IRA distribution.² Medical withdrawals stay completely tax-free, which is why the HSA remains more valuable for health costs than for general spending.

Enrolling in Medicare ends your ability to contribute. The contribution limit drops to zero starting the first month of Medicare coverage, and the rule applies retroactively if your Medicare enrollment is backdated. Contributions made during that retroactive window become excess contributions.⁴ The balance you already have is untouched; only new contributions are blocked.

On the spending side, Medicare premiums become a qualified expense. HSA funds cover Part A, Part B, Part D, and Medicare Advantage premiums tax-free. Medigap supplemental policies are the exception and don’t qualify.⁴

Reporting HSA Activity on Your Taxes

Any year you contribute to or withdraw from an HSA, you file IRS Form 8889 with your tax return. It reports contributions, calculates any deduction, and tracks distributions so the IRS can see whether you owe additional tax. You file it even if you’d otherwise have no reason to file a return.⁷

Your custodian sends you Form 1099-SA early the following year, listing the gross distributions, any earnings distributed with excess contributions, and a code describing the type of withdrawal.⁸ You use the 1099-SA numbers to complete Form 8889. The custodian also files Form 5498-SA reporting your contributions directly to the IRS; your copy is for your records.

If You Withdrew for the Wrong Reason by Mistake

Pull the money for something that turns out not to qualify, or take the wrong amount because of a billing error, and you can put it back. The IRS allows repayment of a mistaken distribution when the withdrawal happened because of a mistake of fact due to reasonable cause.⁸

The deadline to return the funds is the due date of your tax return, without extensions, for the first year you knew or should have known the distribution was a mistake. Repay in that window and the distribution stays out of your gross income, avoids the 20% penalty, and doesn’t count against the annual contribution limit.⁸

1
Office of the Law Revision Counsel. 26 USC 213 Medical, Dental, Etc., Expenses
2
Office of the Law Revision Counsel. 26 USC 223 Health Savings Accounts
3
Internal Revenue Service. Individuals Who Qualify for an HSA
4
Internal Revenue Service. Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans
5
Internal Revenue Service. Publication 502, Medical and Dental Expenses
6
Internal Revenue Service. What Kind of Records Should I Keep
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Internal Revenue Service. Instructions for Form 8889
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Internal Revenue Service. Instructions for Forms 1099-SA and 5498-SA