CJ631,
Didn't see your posting until just now. You do have a choice, though not exactly the one you outlined. (You can't "undo" a distribution.)
(A) Leave the tax return alone and don't ask for insurance reimbursement, or
(B) You can obtain insurance reimbursement and pay the 20% tax penalty for non-medical expenditures. (If you've already filed, you can amend the return before April 18th to avoid any additional dings beyond the 20% penalty.)
Option B makes financial sense as the insurance reimbursement is effectively a 100% credit from which the tax of 20%+your_marginal_tax_rate is subtracted. Since even the highest marginal tax rate is far less than 80%, you come out ahead financially marking the reimbursed expenses as non-medical distributions.
