Using your Health Savings Account (HSA) card for non-medical purchases triggers significant financial consequences, including additional taxes and penalties on the withdrawn amount.
Understanding the Consequences
If you use your HSA funds for expenses that are not qualified medical expenses, the IRS considers that money a taxable distribution. This means you lose the tax-free benefit of the HSA for that specific amount, and face further repercussions.
Taxable Income and Penalties
The primary consequences involve paying taxes and, in most cases, a penalty:
- Income Tax: The amount of money you withdraw for non-medical purposes is added to your gross income for the year. This means it will be taxed at your ordinary income tax rate, just like your regular wages.
- 20% Penalty: If you are under the age of 65 at the time of the non-medical withdrawal, an additional 20% penalty is applied to the amount spent. This penalty is designed to discourage using HSA funds for anything other than their intended purpose.
To illustrate, here's a quick summary of the financial implications:
| Age of Account Holder | Tax on Non-Medical Withdrawal | Additional Penalty |
|---|---|---|
| Under 65 | Standard Income Tax | 20% |
| 65 or Older | Standard Income Tax | None |
Even if you are 65 or older, while the 20% penalty is waived, the non-qualified distribution is still subject to income tax. This means HSA funds can essentially function like a traditional IRA in retirement if not used for medical expenses, but they lose their tax-free withdrawal advantage.
Why HSAs Are Restricted
Health Savings Accounts are tax-advantaged accounts designed to help individuals save for current and future qualified medical expenses. They offer a triple tax advantage: contributions are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are tax-free. To maintain these significant tax benefits, the IRS imposes strict rules on how the funds can be used.
What Qualifies as a Medical Expense?
A qualified medical expense is broadly defined by the IRS as costs for the diagnosis, cure, mitigation, treatment, or prevention of disease, and for treatments affecting any structure or function of the body. Common examples include:
- Doctor's office visits
- Prescription medications
- Dental care
- Vision care
- Lab tests
- Hospital services
- Acupuncture
- Chiropractic care
For a comprehensive list of what the IRS considers a qualified medical expense, refer to IRS Publication 502, Medical and Dental Expenses.
Accidental Non-Medical Purchases: What to Do
Mistakes happen, and you might accidentally use your HSA card for a non-qualified expense. If this occurs, it's crucial to take immediate steps to rectify the error:
Rectifying an Error
- Return the Funds: The best course of action is to return the non-qualified funds to your HSA as soon as possible. If you return the money to your HSA within the same tax year, it can often avoid the taxable event and penalties. Consult your HSA administrator for the proper procedure.
- Keep Meticulous Records: If you cannot return the funds, or if it's a new tax year, ensure you keep detailed records of the non-qualified purchase. This documentation will be essential for accurately reporting the distribution on your tax return (Form 8889, Health Savings Accounts (HSAs)). The IRS may request proof that your distributions were for qualified medical expenses.
Important Considerations
- Tax Reporting: Your HSA administrator will issue Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, which reports all distributions from your account. You are responsible for determining which distributions were for qualified medical expenses and reporting them correctly on your tax return.
- Record Keeping: Always retain receipts for all purchases made with your HSA funds. This is vital because the burden of proof is on you to demonstrate to the IRS that withdrawals were for qualified medical expenses, especially in case of an audit. Keep these records for at least three years from the tax filing deadline.
Avoiding Pitfalls
To prevent unintentional non-medical purchases with your HSA card:
- Separate Accounts: Consider using a separate personal checking account or credit card for everyday, non-medical purchases to avoid confusion.
- Verify Eligibility: Before making a purchase, if you're unsure whether it qualifies as a medical expense, consult IRS Publication 502 or check with your HSA administrator.
- Budgeting: Allocate funds carefully, ensuring you have enough for both qualified medical expenses and regular spending.
By understanding the rules and being diligent with your HSA usage, you can fully leverage its powerful tax benefits for your healthcare needs.
