Contribution on ineligible HSA

[Matyon267]

Hello,

I contributed the max contribution in 2022 and 2023 and also invested those contributions to gain earnings. I realized I did not qualify all this time in 2025 and looked into correcting this. 

Does this mean I will now be double income taxed from both the contribution and withdrawl?

Here is what I am doing and please let me know if I am missing something.

2022: Amending tax to repay income tax on 7300 contribution. Pay 6% fee on year end balance of account.

2023: Amending 7750 contribution. Pay 6$ fee on year end balance of total account 

2024: did not contribute. Did not withdraw. Paying 6% on total balance.

2025: I was told by HSA account that I cannot do a withdrawal of excess form for 2022 and 2023 as it's past deadline. Withdrew account completely from HSA. Does this mean I have to pay the entire amount of the account now as income tax again along with the 20% fee for non medical use? Even after amending and paying back the income tax of contributions from prior years?

[BillM223]

The way the IRS (well, Congress, the author of the Tax Code) sees it, they gave you two chances to handle the excess contributions:

1. withdraw the excess before the due date of the return, and

2. carry over the excess to a future year when you are eligible to take the carryover as a personal contribution.

If you did not have the opportunity to do either, then the carryover of the excess is cured by only one thing: distributing the excess as a distribution not for qualified medical expenses, So, yes, this means that you will owe income tax again on that amount plus the 20% penalty.

If you don't have much in your HSA or are approaching 65, there are some options to think about.

1. The penalty for a carryover is 6% of the LESSER of the carryover amount or the value in your HSA at the end of the year. This means that once the money in your HSA drops to zero, there will be no more penalty.

2. Once you get to 65 years of age, the 20% penalty goes away, although you will still owe income tax on the amount withdrawn, like you would with an IRA. This will also cut the carryover off.

[Matyon267]

Appreciate the confirmation. If I didn't panic withdraw I could have actually just gotten the hsa durring open enrolment and fixed it for future years but oh well. Glad to know now so I can pay the fee quarterly this year. Thanks!

[Opus 17]

For 2022-2024 you are correct, you must amend and pay the 6% penalty each year.

For 2025, the HSA bank is correct, it is too late to use the special procedure to remove the excess contributions.  

There are two ways to remove the excess contributions.

1. Make a withdrawal of the excess amount (ignoring the earnings, just the contribution amount).  Do not use it for medical expenses.  On your 2025 tax return, you will be charged income tax plus a 20% penalty.  That will remove the excess from the account for the future.

2. If you are eligible for HSA contributions in the future, you can apply the excess to your current year eligibility.  For example, if you enroll in a qualifying HDHP for 2026, you would not make new contributions, but instead the 2026 limit (probably will be around $4400 for single and $8800 for family, although the amounts have not been announced) would be applied to the 2022 and 2023 contributions, using some of them up.  You would then pay a reduced 6% penalty on the remaining excess, which you could use up in the same way in 2027.

Because of the hefty tax and penalties on a regular withdrawal (method 1), if you think you will be enrolled in qualifying insurance in the next 4-5 years, it will probably be less costly to pay the ongoing 6% penalty and eventually use up the excess when you are eligible.  If you don't plan on enrolling in an HDHP in the next 5 years, you should probably remove the excess, as painful as that would be. 

[Matyon267]

Hello Opus,

If I withdrew my entire account (contributions plus earning) do I report all of that to be taxed 20 percent withdraw fee. Or can earnings be withdrawn without a fee and only charged on the contributions made?

[BillM223]

In this case, you would pay the 20% penalty on everything you withdrew (contributions and earnings), because this withdrawal was not done pursuant to the protocol for withdrawing excess contributions before the due date for the tax year.

All of this amount will be subject to income tax as well.

This is why Opus discussed your future - will you have HDHP coverage in the next several years? If so, it may be cheaper to just pay the 6% every year until you become eligible to contribute to an HSA. As Opus said, in that future year under HDHP coverage, your carryover will start to be "used up" as a personal contribution (line 2 on the 8889).

[Opus 17]

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@Matyon267 wrote:

Hello Opus,

If I withdrew my entire account (contributions plus earning) do I report all of that to be taxed 20 percent withdraw fee. Or can earnings be withdrawn without a fee and only charged on the contributions made?

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If you withdraw the entire account, any amount used for medical expenses will be tax free and penalty free.  Any amount not used for medical expenses will be subject to income tax plus a 20% penalty.  Then, at the end of the year, you will not be assessed any future 6% penalty, because that penalty is based on the excess contributions or remaining balance, whichever is lower.