@jfm2023 wrote:
Is there a third option whereby she can just pay a tax on the HSA contributions that her employer made? Next year she will want her HSA and I will not be able to claim her as my dependent since she will be 24 before the end of the year.
There are two issues affecting her eligibility.
1. She can't make contributions if she is a dependent.
2. She can't make contributions if she is covered by non-HDHP insurance, even if she is also covered by HDHP insurance.
So she is not eligible for 2024. Will she be eligible for 2025? It depends on her insurance. If she is only covered by her own HDHP, then she is eligible, and she can use the last month rule to contribute up to the full year limit. But, if she will be covered by your insurance as well (that is allowed up to age 26), then she can't contribute for 2025 unless your insurance that covers her is also an HDHP.
The consequences for leaving the money in the HSA are that it is added to her taxable income AND she pays a 6% penalty. The consequences for removing the money as an excess contribution is that it is added to her taxable income but she does not pay the penalty. (So it is added to her taxable income either way.). She does not have to return it to the employer, she can keep it.
And, if she did leave the money in the account and pay the 6% penalty, then next year she can apply it toward the 2025 limit and "use it up". In other words, since the 2025 limit for a single HDHP is $4300 and she has a $1500 excess, that excess will be used up in 2025 as long as she contributes $2800 or less of new funds.
So if you do nothing, she pays income tax plus a $90 penalty and can contribute $2800 next year. If she withdraws the excess she pays income tax, no penalty, and her 2025 limit is the full $4300.
To withdraw the excess, you have to ask for a special procedure at the HSA bank, it is not a regular withdrawal. They must also return any interest that was earned, and that is taxable "other income" on her 2024 return even though the interest is not actually paid to her until 2025.
