What Happens to My HSA If I No Longer Have a HDHP?

Health Savings Accounts (HSAs) offer a tax-advantaged way to save for medical expenses but are linked to having a High Deductible Health Plan (HDHP). Understanding what happens to your HSA if you no longer have an HDHP is essential for managing healthcare finances effectively.

Retention of Existing Funds

When you no longer have a High Deductible Health Plan (HDHP), your existing Health Savings Account (HSA) funds remain yours indefinitely. This means that while you may no longer qualify to make new contributions, the money in your account is unaffected and can continue to grow tax-free. This feature makes HSAs a flexible tool for long-term healthcare savings.

Account holders can allow HSA funds to accumulate over time, with the option to invest in financial instruments like mutual funds or securities offered by the HSA custodian. While investments can potentially lead to significant growth, they also carry market risks. Individuals should weigh their risk tolerance and investment goals when deciding how to manage their funds.

Contribution Restrictions

Once you no longer have an HDHP, the IRS prohibits further contributions to your HSA. Only individuals covered by an HDHP are eligible to contribute, as outlined in IRS Publication 969. However, understanding annual contribution limits is still relevant for those who might regain HDHP coverage within the same tax year.

For 2024, the IRS set the maximum HSA contribution limits at $3,850 for individuals and $7,750 for families, with an additional $1,000 catch-up contribution for those aged 55 and older. If you regain HDHP coverage during the year, contributions can be prorated based on the number of months you were eligible. This is calculated by dividing the annual limit by 12 and multiplying by the months of coverage.

Tax Reporting Implications

Tax reporting for an HSA becomes more complex if you no longer have an HDHP. IRS Form 8889 is used to report HSA contributions, distributions, and determine the taxability of withdrawals. Contributions made while covered by an HDHP must be reported accurately, particularly if prorated limits apply.

Form 8889 also requires reporting of any HSA withdrawals, whether for qualified medical expenses or other purposes. Non-medical withdrawals are subject to regular income tax and, for individuals under 65, an additional 20% penalty. For those over 65, the penalty is waived, but the distribution remains taxable. Keeping thorough records of medical expenses is critical to prove the tax-free status of qualified withdrawals if audited.

Using Funds for Medical Expenses

HSA funds can cover a broad range of qualified medical expenses as defined by the IRS under Section 213(d) of the Internal Revenue Code. These include not only medical bills but also dental and vision care, prescription drugs, and certain over-the-counter medications. This flexibility allows individuals to manage out-of-pocket healthcare costs effectively, even without HDHP coverage.

Using HSA funds for qualified expenses ensures tax-free withdrawals, preserving the account’s tax advantages. Before using funds for elective procedures or alternative treatments, consult IRS guidelines to confirm eligibility. Strategically timing withdrawals for larger expenses or during years with higher medical costs can help maximize tax savings.

Potential Penalties for Ineligible Contributions

If you contribute to an HSA while no longer covered by an HDHP, you risk penalties for excess contributions. The IRS imposes a 6% excise tax for each year the excess remains in the account, as detailed in Section 4973 of the Internal Revenue Code. This penalty applies regardless of whether the contribution was intentional or accidental.

To avoid penalties, excess contributions must be withdrawn before the tax filing deadline, including extensions, for the year in which they were made. Any earnings from the excess amount must also be withdrawn and reported as income. For instance, if you contributed $500 while ineligible and earned $20 in interest, both amounts must be removed to avoid the excise tax. Failure to correct the excess results in the 6% tax being applied annually.

The IRS does not notify taxpayers of excess contributions, so account holders must monitor their contributions and eligibility. Reviewing HSA limits and consulting a tax professional can help ensure compliance, particularly if HDHP coverage changes mid-year and prorated limits apply.