What Happens If I Close My HSA Account?
Explore the implications of closing your HSA account, including tax effects, fund distribution, fees, and options for managing remaining balances.
Health Savings Accounts (HSAs) offer a tax-advantaged way to save for medical expenses, making them a popular choice among individuals with high-deductible health plans. However, closing an HSA can have significant implications for taxes, fund distribution, and future financial planning.
Tax Treatment After Closing
Closing an HSA impacts its tax benefits. These accounts provide tax-deductible contributions, tax-free earnings growth, and tax-free withdrawals for qualified medical expenses. After closure, any distribution not used for qualified expenses becomes subject to income tax, with an additional 20% penalty for those under 65, as outlined in Internal Revenue Code Section 223.
The timing of closure is also important. If the account is closed mid-year, contributions must be prorated based on the months the HSA was active to comply with IRS annual limits—$3,850 for individuals and $7,750 for families in 2024. Contributions exceeding these limits can incur a 6% excise tax unless corrected before the tax filing deadline.
Distribution of Remaining Funds
Careful handling of remaining funds is essential to avoid tax liabilities and penalties. Distributions for qualified medical expenses remain tax-free, underscoring the importance of maintaining detailed records. However, withdrawals for non-medical purposes are subject to regular income tax and, for those under 65, a 20% penalty.
Transferring funds to another HSA through a trustee-to-trustee transfer avoids taxes and penalties, preserving the account’s tax-advantaged status. This can be a practical option for those expecting ongoing healthcare needs.
Bank or Custodian Fees
Closing an HSA often involves fees charged by the bank or custodian, which typically range from $25 to $50. Reviewing your custodian’s fee schedule can help anticipate these costs.
In some cases, maintenance fees may continue until the closure process is complete, potentially reducing the remaining balance. Certain custodians offer fee waivers for maintaining a minimum account balance or meeting specific conditions, which can be advantageous if transferring funds rather than closing the account entirely.
Impact on Medical Expenses
Closing an HSA eliminates the ability to save for medical costs with pre-tax dollars, potentially increasing future out-of-pocket expenses. Those who rely on HSAs to cover significant medical costs may need to reevaluate their financial strategy.
Alternatives like Flexible Spending Accounts (FSAs) or Health Reimbursement Arrangements (HRAs) exist but come with different rules and limitations. For example, FSAs often have a “use-it-or-lose-it” policy, which can be less flexible than HSAs. Careful budgeting for medical expenses becomes critical without the benefits of an HSA.
Transfer or Rollover Choices
Transferring or rolling over HSA funds allows individuals to maintain tax advantages without incurring penalties, provided IRS rules are followed. A direct transfer moves funds between custodians, reducing the risk of errors and penalties. This option is especially useful when switching employers with different HSA providers.
A rollover involves withdrawing funds and redepositing them into a new HSA within 60 days. While this offers flexibility, it requires precise timing to avoid tax consequences. The IRS limits rollovers to one per 12-month period, highlighting the need for strategic planning. Proper documentation is essential to ensure compliance and avoid complications.
Recordkeeping Requirements
Closing an HSA does not eliminate the need for detailed recordkeeping. Retain documentation to substantiate the use of funds for qualified medical expenses, such as receipts and invoices, for at least seven years.
Keep Form 1099-SA, which reports HSA distributions, and Form 8889, which details contributions and distributions, for tax filing purposes. These records are critical for resolving any discrepancies with the IRS and ensuring compliance during audits. Staying organized provides peace of mind and simplifies the process of managing past HSA transactions.