HSA Reform Bill Limits Tax Deduction for Earners Over $200K, Ends Penalty-Free Withdrawals After 2025

A new bill aims to overhaul Health Savings Accounts (HSAs), which many busy people use as a triple-tax-advantaged savings vehicle for medical costs. If passed, these changes—slated to take effect starting in 2026—will fundamentally alter how HSAs work, especially for higher earners and those who value the account’s flexibility.

The biggest shift is the introduction of an income cap on deductible contributions (Sec. 3). Currently, anyone with a high-deductible health plan can contribute and deduct that money from their taxable income. This bill changes that: if your Modified Adjusted Gross Income (MAGI) hits certain thresholds—like $200,000 for single filers or $300,000 for those filing jointly—your ability to deduct those HSA contributions starts shrinking. For someone filing singly, the deduction disappears completely once their MAGI hits $240,000. Essentially, the government is saying that above a certain income level, you can still save in an HSA, but you lose the immediate tax break that makes the account so attractive.

The Flexibility Tax: Goodbye Penalty-Free Withdrawals

Right now, one of the HSA’s most underrated features is its flexibility once you turn 65. If you haven't spent the money on medical costs, you can withdraw it for any reason without penalty (you just pay income tax, similar to a traditional 401k). The bill strikes this exception (Sec. 2), meaning that after December 31, 2025, if you take money out for non-medical reasons, you’ll face the same penalties as withdrawing from an IRA early. For those who viewed their HSA as a backup retirement account—a tax-free medical fund that converts to a tax-deferred retirement fund later—that option is gone.

Two Years to Claim: The New Reimbursement Deadline

Another major change affects how you reimburse yourself for medical expenses. Many people let their HSA funds grow tax-free for years, paying medical bills out-of-pocket and saving the receipts to reimburse themselves decades later. This bill introduces a strict two-year limit (Sec. 4). If you pay a medical bill on January 1, 2026, you must reimburse yourself from your HSA by January 1, 2028, or you lose the ability to use those tax-free funds for that expense. This forces account holders to become meticulous record-keepers and potentially reduces the long-term tax-free growth potential of the account.

New Rules for Proving Your Expenses

The bill also tightens up the rules on what qualifies as a medical expense and how you prove it (Sec. 5). Moving forward, distributions are only considered tax-free if they are “properly substantiated.” If you need a doctor’s opinion to prove an expense is medically necessary (like a special bed or certain therapy), that opinion now has to come from an assessment based on a “genuine provider-patient relationship.” Furthermore, the bill explicitly excludes certain expenses (Sec. 6), such as spa and beauty treatments, and limits how much you can spend on exercise equipment to $500 per year.

The Government vs. Administrative Fees

Finally, the legislation takes aim at the financial institutions that manage HSAs. It creates a new excise tax on "excessive" HSA fees (Sec. 7). The Treasury Secretary is given broad authority to determine what a “reasonable amount” is for every type of fee—maintenance, transfer, withdrawal, etc.—and then tax the trustee for anything above that amount. This is meant to protect consumers from high fees, but it gives the Secretary significant power to dictate the pricing structure for HSA providers. Trustees will also have to start reporting detailed information on all fees charged and the average yield earned on cash balances (Sec. 8), giving the government and consumers a clearer picture of how these accounts are being managed.