Excess HSA Contribution in 2018

[KS66]

n January 2019 I made a $5000 contribution to my HSA to fully fund it for 2018 and filed my taxes for 2018. In February 2019 I filed for my Social Security Benefits. I did not take Medicare Part B because I was still working. I retired in Sept 2019. I now realize that my Medicare Part A started on September 1, 2018. I know that my prorated contribution amount for Jan. 1, 2018 to Sept 1, 2018 is $5266.64. What is the best way to handle the excess contribution of $2633.36 ? do I request a return for the Excess Contribution and Amend my 2018 tax return ? or just withdraw it and pay the taxes in 2019 ? What is ersiehst and cleanest to do ?

[dmertz]

The deadline for obtaining a return of this excess contribution before the due date of your tax return was October 15, 2019, a date that has passed.  You must file an amended 2018 tax return with amended 2018 Form 8889 to report the $2,633.33 excess contribution and pay the 6%, $158 excess contribution penalty.  Since you will never again be eligible for an HSA contribution which would allow you to apply the excess as a subsequent year, to avoid another penalty of 6% on the lesser of the $2,633.33 or the 2019 year-end balance in the HSA you need to either take a taxable distribution of the $2,633.33 or fully deplete the HSA by the end of 2019.

A taxable distribution in 2019 is made by taking it out of the HSA and not claiming it on 2019 Form 8889 as having been applied to a qualified medical expense (even if you actually did spend it on a medical expense).  Presumably you are age 65 or over, so a taxable distribution will not be subject to any early-distribution penalty, just to income tax.

As I mentioned, since the 6% penalty is calculated on the greater of the amount of excess or the year-end balance in your HSAs, so fully depleting your HSA nontaxably by applying it all to qualified medical expenses (as an alternative to or in combination with making a taxable distribution of the excess) will result in an excess contribution penalty of 6% of $0 even though the excess technically remains.

[Confused15]

I used the last month rule in 2018 for family HDHP coverage.  That family included myself, my spouse, and my college student/still a dependent daughter.  My spouse is older than I am, and he will be claiming Medicare Part A in early 2020 which will retroactively become effective 11.1.19.  Thus, since he turned 65 in November of 2019, he is no longer eligible for HDHP/HSA under "family". 

My question-- since my daughter and I are still "family" and she will again be a dependent for 2019 do I pass the last month test? Together she and I will have had continuous HDHP coverage from 10.1.18 through and including 12.31.19?  Help is appreciated on this obscure topic. 

[KS66]

Sorry I was out of Town.. I have approx $2700.00 in unreimbursed medical costs.   So, if I use the Excess  of $2633. for these medical costs to deplete the HSA  Account by the end of 2019 I would not be penalized ?  Do I still need to amend the 2018 return as well as the appropriate form for that Excess and pay the tax ? 

[dmertz]

As I said previously, you must file an amended 2018 tax return to include Form 5329 and pay the 6% excess contribution penalty on the $2633 excess contribution for 2018.

If before the end of 2019 you fully deplete your HSA, leaving a balance of zero, by applying the money to qualified medical expenses the excess contribution penalty for 2019 will be zero because the penalty is 6% of the lesser of the excess or your year-end balance.  The only way that your HSA balance could ever later become nonzero and cause the excess to come back to haunt you is if you inherit an HSA from your spouse.

[krshaf01]

I made an excess contribution to my HSA in 2018, which was caused by Medicare being activated March 1, 2018. I paid $16 in penalty in 2018 on the excess. The problem did not get corrected in my 2019 or 2020 taxes, so $16 has been paid out for two more years. I have been trying to resolve this issue and to find the proper tax professional to answer this question. My HSA fund manager has stated that they can only compute the effective gain/loss up through October 15, 2019. They state that I now must contact a tax adviser and that I cannot use the “Excess Contribution” method. I gather from the comments below, I should take a non-qualified distribution of the $296 in 2020, plus an additional amount that would more than cover any gain that would have resulted. It is understood that this would cause a tax event in 2020. I’m unsure as to whether this distribution would stop the flagging of an excess contribution in TurboTax and the $16 tax event warning. My other option appears to be to spend down the HSA account to $0 and avoid inheriting an HSA. I think the comment about not inheriting another HSA is indicative of the warnings posted on the HSA manager’s site about spending the Core account value into a negative tax situation. This is why they are recommending that good tax advice be pursued. I'm unsure as to whether my stated approach is an iron-clad solution.

[WendyN2]

In my professional opinion and experience with HSAs, I would advise you to spend down the HSA account to zero as you stated being your "other option" to the first one. The amounts appear to not be too great for you to be able to use these funds towards anything medically related. There are even OTC items that qualify for the spending limits (types of spending, not amounts) for HSAs. I believe the initial idea was to be a good one for both employers and employees, but history has shown that it is more of a hinderance to the employee in a big way. 

[krshaf01]

Thank you for your reply. The spend down approach is definitely an approach that I have been considering. The account has about $10K in it so that will take some time. The time required is an issue and from what I have read, the tax issue with the IRS does not really go away. They may not be pursuing taxpayers on this issue though. My HSA Manager has state that they can no longer calculate the gain and I will need to take a non-qualified distribution of the Excess Amount. I would need to establish the resulting gain on my own. So I'm moving toward the approach of taking the $296 excess contribution plus the gain amount as a distribution. My approach would then be to add an additional amount of money in the requested distribution to ensure compete coverage. Taking an additional amount is no big deal. Does this approach allow the problem to be closed, or are there other issues that I'm not seeing? I have not used the account so this minimizes the complexity of problem. I cannot exercise any of the typical options cited throughout the internet, because I have retired and am on Medicare.  My one concern is the non-qualified distribution would not be directly associated with the Excess Contribution but the accounting may consider it a fix.  Thx

[Opus 17]

At this point, it is far too late to make a "return of excess contributions."  That had to be done before April 15, 2019.  (I believe there is a provision to remove the excess in the following year, but that would only extend the deadline to April 15, 2020.  Also, I don't fully understand that provision and you would need help from another expert.)

That excess must remain in your account and will accrue a 6% penalty every year until your account is spent down.  (The penalty is 6% of the excess contribution, or 6% of the account balance on December 31, whichever is smaller.)  If your penalty is only $16, then I guess your excess contribution is just $266?  That's not too bad.  $16 per year is just the equivalent of a slightly larger than normal account maintenance fee.  But, you are stuck with it until the end.

[Opus 17]

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@krshaf01 wrote:

Thank you for your reply. The spend down approach is definitely an approach that I have been considering. The account has about $10K in it so that will take some time. The time required is an issue and from what I have read, the tax issue with the IRS does not really go away. They may not be pursuing taxpayers on this issue though. My HSA Manager has state that they can no longer calculate the gain and I will need to take a non-qualified distribution of the Excess Amount. I would need to establish the resulting gain on my own. So I'm moving toward the approach of taking the $296 excess contribution plus the gain amount as a distribution. My approach would then be to add an additional amount of money in the requested distribution to ensure compete coverage. Taking an additional amount is no big deal. Does this approach allow the problem to be closed, or are there other issues that I'm not seeing? I have not used the account so this minimizes the complexity of problem. I cannot exercise any of the typical options cited throughout the internet, because I have retired and am on Medicare.  My one concern is the non-qualified distribution would not be directly associated with the Excess Contribution but the accounting may consider it a fix.  Thx

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Remember that after age 65, the distribution rules on the account change.  You can still withdraw money for qualified medical expenses tax-free (even if you can't make contributions), or you can make withdrawals for any other reason and only pay regular income tax with no penalty (as if it was an IRA).

If the penalty is really only $16 per year and you have $10K in the account, I would just continue to spend it for your medical expenses, like Medicare Part B and D premiums, co-pays, and so on.   Should you be so lucky as to live 30 years with no unusual medical expenses, you still will have only paid $480 in penalties, and you can earn that back in two years by investing half the balance in a conservative mutual fund.  And if your HSA bank does not offer mutual funds as an investment, you can open an HSA at any other bank that does and do a rollover into the new account.

I would not take the IRA route and withdraw the money to close the account and pay tax on it.  The ability to pay your medical expenses tax-free is too significant a savings to worry about a $16 penalty.