Should You Close Your Health Savings Account If You Have Little or No Balance?

The quick answer is “no.”  If you do, you may miss out an opportunity to pay future expenses tax-free.

I frequently get questions from Health Savings Account owners about closing their account because they’ve drawn down the balance to zero or something close to it.  Sometimes they are being nudged by their HSA provider to close the account due to a lack of activity in the account.  Other times they think they no longer need the account and can’t contribute to it this year because they are no longer covered by an HSA-qualified health insurance plan or they enrolled in Medicare or some other disqualifying coverage that cancels their HSA eligibility.  So they think they no longer need the account. 

What should you do?  It depends on your situation.

If you turned age 65 and enrolled in Medicare, you will definitely not be eligible to make future contributions to your HSA because enrollment in Medicare cancels your HSA eligibility going forward.  If you are in this situation and have a minimal balance, it probably makes sense to withdraw the remaining balance and close your HSA.  If you have receipts for eligible expenses that equal or exceed the amount you have left to withdraw, you will not owe any taxes on the amount you withdraw.

Most people on Medicare should have no problems finding eligible expenses to reimburse because Medicare premiums are an eligible expense once the account owner turns 65, even if they are having the premiums deducted automatically from their monthly Social Security check.  Also eligible are any amounts they paid for Medicare deductibles, copays or coinsurance.

In the unlikely case that you have no eligible expenses, you can still withdraw the remaining funds from your HSA but you will owe ordinary income tax (but no penalty) on the amount you withdraw.  Don’t forget to report this on Form 8889 when you file your income tax return.

But if you are under age 65 and lost your HSA eligibility because you are no longer covered by an HSA-qualified health insurance plan, or you are temporarily covered by other insurance or coverage (such as when your spouse signs up for their employer’s health FSA) that disqualifies your HSA eligibility, there are good reasons not to close your HSA.  Here’s why.

The date that you establish your HSA is extremely important, so make sure you understand when the official date is.  The reason why it is so important is that any eligible expenses incurred on or after that date are eligible for tax-free reimbursement from your HSA without any future time limit.  That means that you can reimburse future expenses that you have one, five, ten or more years from now.

Since they were eligible expenses and they were incurred after you established your HSA, you can withdraw funds tax-free from your HSA to reimburse those expenses as long as there are funds in your HSA to withdraw.  This includes eligible expenses you incurred during periods when you aren’t eligible to add any new money to your HSA.

Even if you do withdraw all your remaining funds in your HSA, don’t close your account, at least not right away.  You probably don’t realize that you have 18 months before you lose the advantages of owning an HSA.  That’s because the IRS allows you to retain the original establishment date of your HSA as long as you do not have a zero balance for more than 18 months.

Why do this matter?  You never know when you might regain your HSA eligibility and be able to start adding new funds to your HSA, then use those funds to reimburse eligible expenses you incurred during that 18-month period or other expenses that were incurred before that period began that you had not yet reimbursed.

The downside of keeping our account open is that you may have to pay account fees to prevent the balance from being drawn down to zero or keep the account open if it is already zero.  But the benefit you might gain could well outweigh this downside.

The final decision about whether or not to close your HSA is yours to make, but there could be very good reasons not to close your HSA when you have a low or zero balance in your account.