How closing an HSA or FSA affects your taxes

Closing an HSA or FSA does not automatically create a tax bill, but what happens depends on whether you withdraw money that was never spent on medical expenses. If you close the account and take out only the funds you actually used for may have access to medical costs, there are no tax consequences. If you withdraw money that has not been used for medical expenses, that withdrawal becomes taxable income in the year you take it out, and you will owe income tax on it.

The rules differ between HSAs and FSAs because they work differently. An HSA is yours to keep — unused money stays in the account and grows tax-free year after year. An FSA is a use-it-or-lose-it account, meaning money you do not spend by the end of the plan year (or the grace period, if your employer offers one) goes back to your employer. When you close either account, the tax treatment of any remaining balance depends on whether that money was ever spent on medical expenses.

Key Takeaways

  • Withdrawing unspent HSA or FSA money for non-medical expenses triggers income tax on that amount in the year you withdraw it.
  • HSAs allow you to keep unused money indefinitely and withdraw it tax-free for medical expenses at any point in the future, even after you close the account.
  • FSAs are use-it-or-lose-it accounts, so money not spent by the end of the plan year (plus any grace period) returns to your employer and is not yours to withdraw.
  • If you withdraw HSA funds before age 65 for non-medical expenses, you owe income tax plus a 20 percent penalty on that amount.
  • Closing an account does not change these rules — the tax treatment depends on how you use the money, not on whether the account is open or closed.

Withdrawing unspent HSA money and the tax penalty

If you close your HSA and withdraw money that has not been spent on medical expenses, you owe income tax on that withdrawal. If you are under age 65, you also owe a 20 percent penalty on top of the income tax. This penalty applies only to non-medical withdrawals; it does not explore to withdrawals you make after age 65, though you still owe income tax on non-medical withdrawals at any age.

The income tax rate you pay depends on your overall income and tax bracket for that year. The 20 percent penalty is a separate charge added to your tax bill. For example, if you withdraw $5,000 in non-medical HSA funds and you are 55 years old, you owe income tax on the $5,000 (at your marginal rate) plus $1,000 in penalties. You will report this on your tax return using Form 8889.

You can avoid this penalty by leaving the HSA open even if you are not contributing to it anymore. Money in an HSA never expires, so you can withdraw it tax-free for medical expenses years or decades later. Many people keep their HSAs open specifically for this reason — the account becomes a long-term savings tool for healthcare costs in retirement.

What happens to unspent FSA money when you close the account

FSA money you do not spend by the end of the plan year does not belong to you — it goes back to your employer. You cannot withdraw it, and you do not owe taxes on it because it was never yours to keep. This is the "use-it-or-lose-it" rule that defines FSAs. If your employer offers a grace period (usually 2.5 months into the next year), you have until the end of that period to spend the remaining balance. After the grace period ends, any unspent money reverts to your employer.

Closing your FSA account does not change this rule. If you close the account before the plan year ends, you lose access to any remaining balance. If you close it after the plan year ends and the grace period has passed, there is no balance left to close — it has already gone back to your employer. The only way to avoid losing FSA money is to spend it on may have access to medical expenses before the important date.

The difference between closing an account and stopping contributions

Closing an account and stopping contributions are not the same thing. You can stop contributing to an HSA or FSA without closing it. If you stop contributing to an HSA, the money already in the account stays there and continues to grow tax-free. You can still withdraw it for medical expenses at any time, with no tax consequences. Closing the account means you are ending it entirely and withdrawing the balance.

For an FSA, stopping contributions means you will not add new money to the account, but you still have access to the balance through the end of the plan year (or grace period). Closing an FSA early means you lose access to any remaining balance when ready. Most people do not need to close an FSA unless they are leaving their job or their employer is discontinuing the plan.

Reporting HSA withdrawals on your tax return

You report HSA withdrawals using Form 8889, which you file with your annual tax return. The form asks you to report the total amount you withdrew and how much of that was for may have access to medical expenses. The difference between total withdrawals and may have access to medical expenses is your taxable non-medical withdrawal. You also report the 20 percent penalty on this form if you are under age 65.

Your HSA provider sends you a statement each year showing all deposits, withdrawals, and the account balance. Keep records of your medical expenses and receipts, because the IRS may ask you to prove that a withdrawal was for a may have access to medical expense. If you cannot prove it was may have access to, the entire withdrawal is treated as non-medical and subject to tax and penalty.

FSA withdrawals do not require a separate tax form because the money is deducted from your paycheck before taxes. You do not report FSA withdrawals on your tax return — the tax benefit is already built into your paycheck through the pre-tax deduction.

Medical expenses you can withdraw for tax-free

Both HSAs and FSAs cover the same list of may have access to medical expenses. These include doctor visits, prescription medications, dental work, vision care, mental health treatment, and many over-the-counter medical items. The IRS publishes a detailed list, but the general rule is that the expense must be for diagnosis, treatment, or prevention of a medical condition.

Some common expenses that do not count as may have access to medical expenses include cosmetic procedures (unless they are medically necessary), gym memberships, vitamins, and toiletries. If you are unsure whether an expense qualifies, check the IRS Publication 502 or ask your HSA or FSA provider before you withdraw the money. Withdrawing for a non-may have access to expense creates a tax bill that you cannot undo.

What to do before you close your HSA or FSA

Before you close an HSA, review your account balance and think about whether you might need it for medical expenses in the future. If you have a balance, consider leaving the account open even if you are not using it right now. There is no annual fee for keeping an HSA open, and the money can be used for medical expenses at any point in your life.

If you are closing an HSA because you are switching to a different health plan, check whether your new plan is HSA-compatible. If it is, you can roll your HSA balance into the new account with no tax consequences. If it is not, you will need to decide whether to withdraw the money (and pay taxes on non-medical withdrawals) or keep the old HSA open.

For an FSA, there is usually nothing you need to do to close it — it closes automatically at the end of the plan year or when you leave your job. If you are leaving your job mid-year, ask your employer whether you can continue using the FSA through the end of the plan year or whether your balance is forfeited when ready. Some employers allow COBRA continuation of FSA benefits, though this is less common than COBRA health insurance continuation.

Frequently Asked Questions

Do I owe taxes if I close my HSA and do not withdraw anything?

No. If you close your HSA but do not withdraw the money, there are no tax consequences. The money stays in the account (or is transferred to a new HSA if you roll it over). You only owe taxes if you withdraw money that was not spent on may have access to medical expenses.

Can I withdraw my FSA balance if I leave my job?

No. FSA money you have not spent by the end of the plan year is forfeited, even if you leave your job. You cannot withdraw it. If you leave mid-year, you may be able to continue using the FSA through the end of the plan year under COBRA, but this varies by employer. Check with your employer's benefits department before you leave.

What if I withdraw HSA money for a medical expense but do not have a receipt?

The IRS does not require you to submit receipts when you withdraw HSA money, but you must keep records in case you are audited. If you cannot prove the withdrawal was for a may have access to medical expense, the IRS will treat it as a non-medical withdrawal and you will owe income tax and penalty on it.

Can I reopen an HSA after I close it?

Yes, you can open a new HSA at any time as long as you are covered by an HSA-compatible health plan. However, you cannot recover money you withdrew for non-medical expenses — that withdrawal is permanent and taxable. If you think you might need the HSA in the future, it is usually better to leave it open rather than close it.

Do I owe the 20 percent penalty on HSA withdrawals after age 65?

No. After age 65, you can withdraw HSA money for any reason without the 20 percent penalty. You still owe income tax on non-medical withdrawals, but the penalty no longer applies. This makes HSAs particularly valuable as a retirement savings tool.