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Health savings accounts offer tax benefits for saving for future health costs. However, not all medical insurance premiums are allowed as qualified expenses when you take withdrawals. If you take money out and use it on non-qualified premiums, you're going to be on the hook for extra taxes and penalties on the distribution.
Only certain insurance premiums count as qualified expenses from your HSA. Eligible premiums include long-term care insurance, continuation insurance such as COBRA, health care while you're receiving unemployment under state or federal law, and Medicare coverage after you turn 65. When you take distributions to pay these costs, like any other qualified expense, the money comes out tax-free and penalty-free from your HSA.
The long-term care insurance premiums you can count as qualified expenses are limited based on the age of the beneficiary. For example, if the beneficiary is under 40 at the end of 2012, you can only count up to $350 as a qualified expense. Payments for continuing insurance and insurance while you're unemployed are qualified, and that includes premiums you pay for your spouse and your dependents. However, if you're under 65, you can't use your HSA to pay for your spouse's Medicare even if your spouse is over 65.
You can take money out of your HSA for other insurance premiums, but those withdrawals count as nonqualified withdrawals. As a result, you have to pay taxes and a 20 percent penalty on the withdrawal. There are limited exceptions from the penalty, such as if you're permanently disabled, over 65 years old or taking distributions as a beneficiary, but those won't be tax-free -- just penalty-free.
Whether your insurance premiums qualify or not, you still have to report the distribution on your taxes. If you spend the money on qualified insurance premiums, report the withdrawal on Form 8889. If it's not qualified, you must also figure the 20 percent early withdrawal penalty on Form 8889 and include the distribution on line 21 of Form 1040 as taxable income. It's taxed just like other ordinary income -- the higher your tax bracket, the more you pay.
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