HSA tax treatment

An HSA lets you save and invest tax-free for your medical expenses. With your HSA, you can:

Contribute pretax dollars or deduct your contributions from your income tax, even if you don’t itemize deductions

Owe no tax on earnings or interest on the account

Withdraw for qualified medical expenses without owing tax on contributions or earnings

You report your contributions and expenditures to the IRS each year when you file your return. Your HSA custodian or trustee will provide forms documenting both, which you attach to your return.

Before you turn 65, if you do withdraw from the HSA for expenses that don’t qualify for tax-free treatment, you’ll owe taxes plus a 10% penalty. After age 65, the story changes: You’ll be able to withdraw from the HSA for any reason without paying the 10% penalty, although you will owe income tax on withdrawals for non-medical expenses.

In fact, because HSAs can also be used for non-medical expenses without penalty after age 65, you might take advantage of the opportunity to invest additional money above the annual caps on individual retirement accounts (IRA)s and employer-sponsored plans for retirement, tax-deferred.

State taxes?

The states must decide individually how to treat HSAs in their tax codes. Essentially, states are in transition — some tax HSA contributions and distributions, and some don’t. If in doubt, the best thing to do is discuss your situation with a professional tax adviser to check your state’s tax treatment of HSAs.

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