With a health savings account, you can pay for eligible medical expenses with tax-free dollars. But what happens if you use your HSA funds to pay for an ineligible expense?

Penalties for Ineligible Expenses Before Age 65

For account holders under the age of 65, if they spend HSA money on ineligible expenses:

  • They’ll owe taxes on that money

  • Plus a 20% penalty on the amount that exceeds their eligible expenses

Example:
If a total of $500 was withdrawn from an HSA during the year, but the account holder only has receipts for eligible expenses totaling $300, then:

  • The excess $200 is reported as taxable income

  • A 20% penalty (or $40) is applied to the excess withdrawal

Using Prior Eligible Expenses to Offset Ineligible Withdrawals

Previous eligible expenses—incurred after the HSA was established but paid out-of-pocket with after-tax dollars—can be used to offset ineligible HSA withdrawals.

Example:

  • Suzy has an HSA-qualified plan in 2025 and sets up her HSA.

  • She visits the doctor and the bill (after the insurance discount) is $100.

  • Instead of using her HSA, she pays with a regular debit card and saves the receipt.

  • In 2026, she can withdraw $100 from her HSA and spend it however she likes—even if the new expense is not eligible—because she already has a $100 eligible expense on file that she paid out-of-pocket.

What Happens After Age 65?

There are no penalties for using HSA funds on ineligible expenses after age 65.

At that point:

  • The HSA functions much more like an IRA

  • Ineligible expenses are taxed, but not penalized

  • Eligible expenses remain tax-free