High Deductible Health Plan Excess Contribution

[snw0]

I have a previous HSA that had an excess (accidental) contribution (from 2022). It is too late to withdraw the excess funds at this point. And, I no longer have a HDHP, so I am not eligible for any contributions in 2023. So, this gives me errors in TurboTax. Here are my questions:

1. Turbo Tax gives me an error because form 8889 asks for me to indicate my coverage under a HDHP in 2023 (and I was not covered in 2023). 

2. Do I need to withdraw the excess contribution? Will I continue to be charged 6% per year if I don't withdraw the money?

Thank you.

[Katie-P]

Hi @snw0,

Thanks for your question!

1. With regards to the flag you're seeing on Form 8889, I understand what you mean. I was able to duplicate that flag in a fake tax return. I advise you to keep the answer as No, you didn't have a HDHP in 2023. You should still be able to e-file the return without any issues. 
2. Unless you want to keep paying the 6% penalty every year on the excess contribution you made in 2022, you would need to take corrective action. I like @Opus 17's response below.

I hope this guidance helps! I'll stay tuned to see if you have any follow-up questions. 

[Opus 17]

Once funds are in the HSA, they may be used for qualifying expenses for yourself, your spouse or your dependents, even if the funds were improperly contributed.  (The rules and penalties for contributions and withdrawals are separate.)

You will pay a 6% penalty for each year the excess funds are in the HSA. The penalty is 6% of the excess contribution, or the balance of the account, whichever is lower.  So if you can use the funds for medical expenses, and eventually spend down the money, the penalty will decline and eventually vanish.  The other way to stop paying the penalty is to withdraw the funds, indicate they were not used for medical expenses, and you will pay income tax plus a 20% penalty.

So what you do depends on your medical expending, the amount of excess, and the amount of your account.

For example, suppose your balance is $5000, of which $3000 is excess, you spend about $2500 per year, and you don't plan on enrolling in an HDHP in the next two years.  If you withdraw the excess and don't use for medical expenses, you will pay over $1200 in tax and penalties.  If you just spend the account for medical needs, your penalty this year would be $150 and next year would be zero because the account would be empty.

On the other hand, suppose your balance is $20,000, your excess is $3000, and your medical needs are $1000 per year.  You will pay about $1200 in income tax and penalties if you withdraw the money and don't use it for expenses, against $180 per year for the next 20 years.