@MrHarriet wrote:
Thanks Opus. This is very informative and helpful! Though, unfortunately, it seems the quickest way to address this is also the most expensive (i.e. withdrawing everything and washing my hands of this whole ordeal)
You are right that I'm under 55. I have not spent anything out of the HSA so far. Though, my wife and I recently had our first child, so your option A, paying for all the medical expenses from the HSA may be a good option for us! I didn't know you could still use the HSA even if the contributions are ineligible. Are there any pitfalls in doing this?
Quickest isn't always cheapest.
Once you have money inside an HSA, you are free to spend it tax-free for qualified medical expenses for yourself, your spouse and your dependents, even if you are not eligible to make new contributions.
Also, you can withdraw funds to reimburse yourself for any qualified medical expenses you had at any time after the HSA was opened, even if you chose not to use the HSA at the time. (You just can't reimburse yourself for expenses that were covered by insurance or the HRA because that would be claiming 2 tax benefits for the same expense.) So you could now withdraw money to reimburse yourself for any out of pocket expenses (co-pays, prescriptions, and so on) going back to mid-2021. And you can continue to withdraw money to pay your out of pocket expenses through Dec 31, 2023. Then at the end of December, you can decide whether to make a clean break of it and withdraw the remaining balance and pay 44%, or leave the remaining balance and pay 6% and carry it to next year. Just be sure to initiate any withdrawals a few days before 12/31, because the withdrawal will count when the bank processes it, not when you request it, and if there is a bank delay at the end of the year, you could have a 12/31 withdrawal that is not actually processed until 1/3/24.
On your 2023 tax return, you will be asked for your total withdrawals, that will be reported on a form 1099-SA that the HSA bank will send you. Then you will be asked if you used all the money for qualified medical expenses, if the answer is no, you will enter the total of medical expenses and Turbotax will assess the penalty on the rest.
