What Happens to HSA Money If Not Used?
Learn what happens to unused HSA funds, including tax implications, withdrawal rules, and how they can be preserved or passed on over time.
Health Savings Accounts (HSAs) allow individuals to save for medical expenses while benefiting from tax advantages. Many account holders wonder what happens to their funds if they don’t use them immediately. Unlike other health-related accounts with strict spending deadlines, HSAs have unique rules that determine how the money is treated over time.
Does HSA Money Expire
Unlike Flexible Spending Accounts (FSAs), which have a “use-it-or-lose-it” policy, HSAs do not have expiration dates. The money stays in the account indefinitely, allowing it to grow. This makes HSAs useful for both short-term medical costs and long-term healthcare planning, especially in retirement when medical expenses typically rise.
Since there is no deadline for spending the funds, account holders can invest their HSA balances in mutual funds, stocks, or other assets, depending on their provider’s options. This allows for tax-free growth, helping some individuals build a substantial healthcare fund for later in life.
Tax Treatment of Unspent Funds
HSAs provide tax advantages not only for contributions and withdrawals but also for unspent funds. As long as the money remains in the account, it grows tax-free, unlike traditional investment accounts where earnings are taxed annually.
If an account holder transfers HSA funds to another provider, they can do so tax-free through a trustee-to-trustee transfer. However, if they withdraw the funds and redeposit them into another HSA, they must complete the process within 60 days to avoid taxes and penalties. Only one such rollover is allowed every 12 months.
While HSAs are tax-advantaged at the federal level, some states impose taxes on contributions or investment gains. Account holders should check their state’s tax laws to understand any potential liabilities.
Qualified vs. Non-Qualified Withdrawals
HSA withdrawals are classified as either qualified or non-qualified. Qualified withdrawals, used for eligible medical expenses, are tax-free. Non-qualified withdrawals, used for non-medical expenses, are subject to income tax and, if taken before age 65, a 20% penalty.
Eligible expenses, as defined by the IRS, include doctor visits, prescriptions, hospital stays, dental care, and certain over-the-counter medications if prescribed.
After age 65, the 20% penalty no longer applies, but non-medical withdrawals are taxed as ordinary income, similar to distributions from a traditional 401(k) or IRA.
A unique feature of HSAs is the ability to reimburse past medical expenses at any time, provided they occurred after the account was established and receipts are properly documented. This allows account holders to let their funds grow tax-free and withdraw money later when needed.
Passing On HSA Funds
What happens to an HSA after the account holder’s death depends on the designated beneficiary. If a surviving spouse is named, the HSA transfers to them and retains its tax-advantaged status. They can continue using the funds for qualified medical expenses without triggering taxes.
If a non-spouse inherits the HSA, the tax benefits end. The entire balance becomes taxable income for the beneficiary in the year of the account holder’s death, which could push them into a higher tax bracket. If multiple beneficiaries are named, each is responsible for taxes on their share of the account.
Understanding these rules helps account holders plan for their own healthcare expenses and the financial impact on their heirs.