Violated last month rule for my HSA

[moyupro]

Hi all,

I was doing my taxes and found out that I misread the Last Month Rule last year when I file.

I was qualified for HSA in 2021 for the last 5 months and switched to a non-HSA-qualified plan in March 2022. I maxed out my 2021 contribution which was $3600 and now TurboTax is saying that there are $2100 that got disqualified and I would need to pay tax and penalty here. I understand that I might not have a chance to correct this, but since I am now gonna pay taxes on that $2100, that will not be pretax anymore. Can I get that $2100 refunded from my Optum HSA account? If yes, do I just need to mail Optum the Excess Contribution and Deposit Correction Request Form? Thanks!

[BillM223]

No, unfortunately, as of April 15, 2022 (or whatever the due date was for 2021), you were no longer able to correct the excess contribution by simply withdrawing the "excess". So do NOT ask the HSA custodian to refund the money as an excess contribution.

Instead, you have to go through those painful questions asking what your contributions were for 2021, your HDHP coverage, etc. 

IRS Pub 969: If you fail to remain an eligible individual during the testing period, for reasons other than death or becoming disabled, you will have to include in income the total contributions made to your HSA that wouldn’t have been made except for the last-month rule. You include this amount in your income in the year in which you fail to be an eligible individual. This amount is also subject to a 10% additional tax. The income and additional tax are calculated on Form 8889, Part III.

NOTE that both underlined items about are done automatically by TurboTax. Once you have finished the "Failure to Maintain HDHP coverage" questions, you are done with this.

[moyupro]

Thank you! So does that mean even after I paid taxes and penalties on that $2100, I still have to leave it in my HSA, and when I wanna use that money after I am 65, I need to pay taxes on that one more time? Am I correct?

[BillM223]

1. Yes, you do not withdraw that money, but you do pay income tax on it as well as a 10% penalty, so whatever is left stays in your HSA.

2. Yes, if you withdraw dollars from the HSA after age 65 for non medical purposes, you pay only income tax on it, but no penalty. It becomes sort of like a funny IRA at that point. Of course, if you withdraw dollars for medical expenses, the withdrawal is still tax-free.