Are HSA Fee Distributions Considered Qualified Expenses?

Health Savings Accounts (HSAs) have become a popular tool for managing healthcare costs while providing tax advantages. However, understanding what qualifies as a legitimate expense can be challenging, especially when it comes to account-related fees.

Determining whether HSA fee distributions qualify as medical expenses is crucial for avoiding tax complications and maximizing the account’s benefits.

Custodian Fees for HSAs

HSAs are managed by custodians such as banks or financial institutions, which charge fees for their services. These may include account maintenance charges, investment management fees, and transaction costs. For example, some custodians charge a monthly maintenance fee of $2 to $5, while others impose a percentage-based fee on assets under management, typically 0.25% to 0.50% annually. Comparing fee structures is essential to ensure that the HSA’s benefits outweigh its costs. For instance, an account with a $3 monthly fee and a 0.3% investment fee on a $10,000 balance would incur $66 annually in fees.

Qualification Status of HSA Fees

The IRS defines qualified medical expenses as those primarily for the prevention or treatment of physical or mental conditions. Fees for maintaining or managing an HSA do not fall under this category. As a result, using HSA funds to pay custodial or management fees is considered a non-qualified distribution, subject to income tax and, for account holders under 65, a 20% penalty. For example, withdrawing $100 from an HSA to cover account fees would add that amount to taxable income, and for those under 65, an additional $20 penalty would apply.

Tax Ramifications for Distributing Funds for Fees

Non-qualified HSA distributions, such as those used for account fees, are subject to income tax. In 2024, federal income tax rates range from 10% to 37%, depending on taxable income. Additionally, individuals under 65 face a 20% penalty on non-qualified withdrawals. For instance, a 40-year-old withdrawing $200 from their HSA for administrative fees would owe both income tax on the $200 and a $40 penalty.

Recordkeeping and Documentation Requirements

Maintaining accurate records is crucial for HSA holders to ensure compliance and avoid issues with the IRS. Account holders should keep receipts and invoices for all medical expenses paid with HSA funds. Many financial institutions offer online tools to help categorize and track transactions. For those using HSAs for investments, preserving statements that document contributions, earnings, and distributions is also advisable.

Potential Penalties for Improper Distributions

Improper HSA distributions can result in financial penalties. Non-qualified withdrawals are added to taxable income, and for individuals under 65, a 20% penalty applies. For example, withdrawing $1,000 for a non-medical expense like a gym membership would result in income tax on the $1,000 and a $200 penalty. For those 65 or older, the penalty no longer applies, but the withdrawal remains taxable. Retirees considering non-medical use of HSA funds should weigh the tax implications carefully. Consulting a tax professional or financial advisor can help ensure compliance and optimize account usage.