Increasing Penalties for Health Savings Accounts

Posted by Jill on June 22, 2010

We continue our in-depth look at the health care bill and how it might impact your finances. This afternoon, we’ll cover HSAs and HDHPs.

I often trumpet the combination of a High Deductible Health Plan (HDHP) and Health Savings Account (HSA) as an effective way to save money on health insurance and receive a tax break on out-of-pocket expenses. The new health care bill won’t do anything to change HDHPs – in fact, they are being used as a model for the new state-sponsored health care exchanges. However, there will be a few key changes to HSAs.

HSA Changes

  • OTC Medicines: Beginning in 2011, HSA funds cannot be used for over-the-counter medicines unless specifically prescribed by a doctor. This is similar to the new restrictions on FSAs, which will prevent funds from being used for items such as contact solution and bandages.
  • Penalty: Unlike FSAs, HSA funds carry over from year to year. So if you max out your HSA and don’t use the funds, you can find yourself with a rather large balance after a few years. You can withdraw the funds for other purposes, but face both income taxes AND a 10% penalty. Starting in 2011, that penalty will become 20%. Currently, the penalty does not apply to those over 65 – since the health care bill does not specifically address that provision, I’m assuming it will stay the same.

HSA Planning and Impacts

If you think you’ll need the money for healthcare expenses now or in the future (or long term care expenses down the road), an HSA is a great way to stash money that can later be used tax free. But if you are making contributions at the expense of retirement contributions or meeting other savings goals, you might want to rethink your strategy. The new penalty means that you could pay 45% on non-qualified withdrawals if you are in the 25% tax bracket. So be sure to save only what you need in an HSA.

In addition, you should stock up on non-prescription medicines before the end of 2010. Starting in 2011, ask your doctor to write
prescriptions if you have the choice between a prescription and non-prescription drug – this will allow you to run the expense through your HSA.

Check out the entire health care series:

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Comments to Increasing Penalties for Health Savings Accounts

  1. I fail to see any downside to saving more than you “need” in an HSA (presumably you mean more than you need to spend on medical expenses.) First of all this account is good for a lifetime, so I can hardly foresee a situation where you would not use the money eventually for medical expenses (and in the meantime earn tax free returns on the money).

    Second of all, even if you never spent another dime on medical expenses, you can use it to supplement your retirement accounts, in that if you wait until you are 65 to take the money out for any reason, it operates much like an IRA, you simply pay the regular tax on what you withdraw. (Thereby enjoying the tax-free accumulation just like you would in a retirement account).

    One final point worth mentioning, if you put the maximum into the HSA and then never use it currently (allowing it to grow tax free) but just save all the receipts for all the medical expenses you incur along the way, you can take that amount out 20 or 30 years from now TAX FREE up to the amount you are reimbursing yourself for all those past expenses (all the while earning tax-free earnings in that account.)

    Tell me again where I should be seeing any downside?


    • What I said was that you shouldn’t save more than you need IF you are doing it at the expense of retirement savings or other savings goals (house downpayment, etc).
      Certainly if you have the free cash flow an HSA is a great way to save for and on medical expenses both now and down the road. But with the new penalties there’s no reason to lock up money that could instead go into a Roth IRA or towards a big purchase.


      • Aaah, yes, absolutely agree.


  2. It essentially functions as an IRA, but one that allows you to draw down funds to cover medical bills. The penalties evidently are put in place to encourage people to save for retirement in any way possible.

    It certainly is true that one day you may land a job with a decent insurance plan, and so quit contributing the HSA. However, at a still later date you could lose that job and need the HSA to cover future medical bills, or, even if you get into another plan, you might need the HSA monehy to cover copays, which these days can be pretty exorbitant. In any event, when you reach Medicare age, any money left in the HSA is yours to spend as you please, just like funds in an IRA.

    When I had an MSA (early version of HSA), I was surprised to discover that many doctors will give you a substantial discount if you tell them you have to pay in cash. A payment directly from the patient is money the doctor gets right away, without having to pay an employee to fight with an insurance company and without having to wait upwards of three months for disbursal.

    If we all could pay in cash for office calls and relatively minor treatments, the cost of medical care would drop significantly, because medical practices could dispense with some highly skilled, expensive staff.

    Funny about Money

    • Good point about paying in cash.

      Just a quick point on your second paragraph -the money is yours after a certain age with no penalties, but you will still have to pay taxes on the withdrawals. Basically functions the way a 401(k) or traditional IRA does.


  3. No one explains what the 20% penalty for using your HSA for non-medical expenses means. Do they send you a bill or is it added to your taxes? My taxes are deducted automatically from my paychecks by my employer, if the 20% penalty is something included in my taxes does that mean I’m responsible for adding it? I’ve checked a dozen sites for explanations and all of them just say “are subject to a 10% penalty (20% starting in 2011).”


  4. Hi Jill,
    I have some expensive surgery coming up. I have a substantial balance in my HSA bank and I can pay for it using my debit card. What I am wondering is if I can pay for the surgery with a credit card instead and then reimburse myself from my HSA account so I can accrue Credit Card rewards?
    Thank you,


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