Is an HSA Withdrawal Taxable? Qualified Expenses and the 20% Penalty

An HSA withdrawal is taxable only when you spend the money on something other than a qualified medical expense. Use the funds for a doctor visit, prescription, dental work, or any other qualifying cost, and the distribution is completely tax-free. Use it for anything else, and the entire withdrawal gets added to your income and hit with an extra 20% penalty on top, though that penalty goes away once you turn 65, become disabled, or die. For 2026, contribution limits are $4,400 for self-only coverage and $8,750 for family coverage.¹

When the Withdrawal Is Tax-Free

Any money you pull out of your HSA and use for a qualified medical expense is excluded from your gross income. No federal income tax, no penalty. It doesn’t matter whether your HSA provider pays the doctor directly or sends you a reimbursement after you’ve already paid out of pocket. The qualifying expense is what makes the distribution tax-free.²

Your HSA can also cover qualified expenses for your spouse and anyone who qualifies as your tax dependent, whether or not they’re on your high-deductible health plan. You can have self-only HDHP coverage and still spend HSA money tax-free on your spouse’s dental work or your child’s prescription.³

Even when a distribution is entirely tax-free, you still report it. Your HSA provider sends a 1099-SA to you and the IRS, and the IRS matches it against Form 8889 on your return. Skipping the form can trigger a notice even when nothing is owed.⁴

What Counts as a Qualified Medical Expense

Qualified medical expenses follow the definition in Internal Revenue Code Section 213(d): costs for the diagnosis, treatment, or prevention of disease, and anything that affects a structure or function of the body. That covers most of what people spend on healthcare — doctor and dentist visits, surgery, prescription drugs, insulin, mental health care, vision exams, eyeglasses, contact lenses, and medical equipment.⁵

Some things that look medical don’t qualify. Cosmetic procedures done purely for appearance, general-health vitamins that weren’t prescribed, gym memberships, and teeth whitening all fall outside the definition. The IRS excludes expenses that are “merely beneficial to general health.”⁵

Insurance Premiums Are Usually Not Qualified

Health insurance premiums are generally not a qualified medical expense for HSA purposes. The IRS carves out four exceptions where premiums can be paid tax-free from an HSA:⁶

COBRA continuation coverage after leaving a job.
Health coverage maintained while you’re receiving unemployment compensation.
Medicare premiums once you’re 65 or older, including Part A, Part B, Part D, and Medicare Advantage. Medigap premiums do not qualify.
Long-term care insurance premiums, up to an age-based annual limit set by the IRS.

If you’re under 65, the Medicare exception doesn’t extend to premiums for a spouse who is 65 or older. The account holder has to be the one who’s reached 65.

The Timing Rule (and No Deadline to Reimburse Yourself)

A distribution is only tax-free for expenses incurred after you established the HSA. A medical bill from January doesn’t qualify if the account wasn’t opened until March, even if you were eligible for an HSA earlier under the last-month rule.⁶

There’s no deadline on the other end. If you paid $2,000 out of pocket for a medical bill in 2022 and your HSA existed at the time, you can withdraw $2,000 tax-free in 2026 to reimburse yourself. The IRS imposes no time limit. This lets HSA investments grow tax-free for years while you reimburse old expenses whenever you want. Keep your receipts, because the burden of proof is on you.⁴

Non-Qualified Withdrawals: Income Tax Plus 20%

Take money out for something that isn’t a qualified medical expense, and two things happen. The withdrawal is added to your gross income and taxed at your ordinary rate. On top of that, you owe an additional 20% penalty tax on the same amount.²

The math gets ugly quickly. Withdraw $5,000 for a vacation while in the 22% federal bracket and you owe $1,100 in income tax plus a $1,000 penalty. That’s $2,100 gone from a $5,000 withdrawal before any state tax. The penalty is calculated on Form 8889, line 17b, and flows to your Form 1040.⁷

Some states don’t conform to the federal HSA framework and may tax distributions at the state level even when the withdrawal is for medical expenses. Check your state’s rules before assuming a distribution is fully tax-free.

When the 20% Penalty Disappears

The 20% additional tax stops applying in three situations:²

You reach age 65. Non-medical withdrawals are still taxed as ordinary income, but the extra 20% goes away. The account starts behaving much like a traditional retirement account.
You become disabled under the IRS definition — unable to engage in any substantial gainful activity because of a physical or mental condition expected to result in death or last continuously for at least 12 months.
You die. Distributions made to beneficiaries after the account holder’s death aren’t subject to the penalty.

In every one of these cases, withdrawals for qualified medical expenses stay fully tax-free. The penalty waiver only matters for non-medical spending.⁴

What Happens to an Inherited HSA

The tax treatment after you die depends entirely on who inherits. If your spouse is the named beneficiary, the account simply becomes their HSA. They keep using it tax-free for qualified medical expenses, and there’s no taxable event at the transfer.⁸

Anyone other than a spouse — a child, sibling, friend — inherits differently. The account stops being an HSA on the date of death, and the full fair market value becomes taxable income to the beneficiary in the year you die. The one offset: the beneficiary can reduce that taxable amount by any of your qualified medical expenses they pay within one year after the date of death. If your estate is the beneficiary, the value is included on your final return instead.⁸

How to Report Distributions

Each year you take any distribution, your HSA provider sends Form 1099-SA. Box 1 shows the total distributed and Box 3 carries a code identifying the type of distribution.⁹

You report the activity on Form 8889, filed with your return in any year you took a distribution, even if none of it was taxable. Part II handles distributions: line 14a is your total distributions from the 1099-SA, line 15 is the amount spent on qualified medical expenses, and line 16 is the difference — your taxable amount. If qualified expenses meet or exceed total distributions, line 16 is zero. Line 17b calculates the 20% additional tax when it applies.⁷

You don’t submit medical receipts with your return, but keep them organized. If the IRS questions a distribution, you’re the one who has to prove the expense was qualified.¹⁰

Fixing a Mistaken Distribution

If your HSA provider distributed money in error — a duplicate payment or an incorrect amount from an administrative mistake — you can return the funds and avoid the tax hit. The repayment has to happen no later than April 15 following the first year you knew or should have known about the mistake.¹¹

This relief applies only to genuine mistakes of fact with reasonable cause. Changing your mind about a withdrawal you meant to make doesn’t count. And if you withdrew money for something you thought was a qualified expense but later learned wasn’t, that’s a non-qualified distribution, taxed and penalized under the normal rules.

1
Internal Revenue Service. IRS Notice 2026-5 – Expanded Availability of Health Savings Accounts Under the OBBBA
2
Office of the Law Revision Counsel. 26 USC 223 – Health Savings Accounts
3
Internal Revenue Service. Distributions for Qualified Medical Expenses
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. Publication 969 (2025), Health Savings Accounts and Other Tax-Favored Health Plans – Section: Qualified Medical Expenses
7
Internal Revenue Service. Instructions for Form 8889 (2025)
8
Internal Revenue Service. Publication 969 (2025), Health Savings Accounts and Other Tax-Favored Health Plans – Section: Death of an HSA Holder
9
Internal Revenue Service. Form 1099-SA Distributions From an HSA, Archer MSA, or Medicare Advantage MSA
10
Internal Revenue Service. About Form 8889, Health Savings Accounts (HSAs)
11
Internal Revenue Service. Distributions from an HSA