Part 3: Qualified Medical Expenses, Tax-Free Withdrawals, and Medicare Rules for HSAs

One of the biggest advantages of a Health Savings Account (HSA) is the ability to withdraw money completely tax-free for qualified medical expenses. However, understanding what qualifies — and what does not — is critical.

Tax Treatment of HSA Withdrawals

HSA withdrawals fall into two categories:

Qualified Medical Expenses

Withdrawals used for qualified medical expenses are:

·       Federal income tax-free

·       Generally state income tax-free in most states

Non-Qualified Withdrawals

Withdrawals for non-medical purposes before age 65 are:

·       Subject to ordinary income tax

·       Subject to an additional 20% penalty

After age 65:

·       The 20% penalty disappears

·       Non-medical withdrawals are still taxable as ordinary income

This effectively causes HSAs to function somewhat like traditional retirement accounts after age 65.

Qualified Medical Expenses

Qualified expenses are generally defined under IRS Section 213(d).

Common qualified expenses include:

·       Doctor visits

·       Hospital expenses

·       Prescription medications

·       Dental care

·       Vision care

·       Eyeglasses and contact lenses

·       Hearing aids

·       Chiropractic care

·       Physical therapy

·       Certain long-term care services

Can You Reimburse Yourself Later?

Yes — and this is one of the most powerful HSA planning opportunities available.

There is no requirement that you reimburse yourself in the same year the expense occurred.

As long as:

·       The expense was incurred after the HSA was established

·       You retained documentation and receipts

·       The expense was never otherwise reimbursed

…you may reimburse yourself years later.

Example

Suppose you paid:

·       $5,000 of medical expenses out-of-pocket in 2026

Instead of reimbursing yourself immediately, you leave the HSA invested.

Fifteen years later:

·       Your HSA may have grown substantially tax-free

·       You can still withdraw the original $5,000 tax-free

Many investors use this approach as a form of “future tax-free emergency fund.”

Medicare Premium Rules

HSAs have special rules once you reach Medicare age.

Premiums That CAN Be Reimbursed Tax-Free

After age 65, HSA funds may generally be used tax-free for:

·       Medicare Part B premiums

·       Medicare Part D prescription drug premiums

·       Medicare Advantage (Part C) premiums

Qualified long-term care insurance premiums may also qualify within annual IRS limits.

Medicare Expenses That CANNOT Be Reimbursed

Importantly, HSA funds generally cannot be used tax-free for:

·       Medicare supplement (Medigap) premiums

This is a commonly misunderstood rule.

Age 65 Changes Everything

Age 65 creates several important HSA changes:

Before Age 65

Non-medical withdrawals:

·       Taxable

·       Subject to 20% penalty

After Age 65

Non-medical withdrawals:

·       Taxable

·       No 20% penalty

This flexibility makes HSAs unique compared to FSAs.

Common HSA Exclusions

Not every health-related expense qualifies.

Typical non-qualified expenses include:

·       Cosmetic surgery (unless medically necessary)

·       General health club memberships

·       Vitamins or supplements for general wellness

·       Over-the-counter items without qualifying medical purpose

·       Teeth whitening

·       Funeral expenses

Always retain documentation supporting medical necessity when applicable.

Recordkeeping Is Critical

The IRS does not require submitting receipts with your tax return, but you should maintain:

·       Receipts

·       Invoices

·       Explanation of benefits (EOBs)

·       Proof of payment

Poor recordkeeping could jeopardize tax-free treatment during an audit.

HSAs as Retirement Planning Tools

Many financial planners now view HSAs as:

·       Supplemental retirement accounts

·       Healthcare reserve accounts

·       Tax diversification tools

Healthcare expenses often rise significantly during retirement. Having a pool of tax-free money available can improve retirement flexibility and reduce future tax burdens.

At Otium Financial Planners, we help clients develop tax-efficient healthcare and retirement income strategies. Whether you are deciding when to reimburse medical expenses, planning for Medicare, or integrating HSAs into your retirement strategy, we can help you create a personalized financial plan.

Contact Otium Financial Planners to learn how an HSA may strengthen your long-term retirement and tax planning strategy.