HSA penalty for non-coverage

[AnnieMacGSP]

For TY2023 I had a high deductible family health plan with an HSA account.  At year end, my ins carrier advised my plan was being discontinued and I was being matched to new plan for TY2024, which I accepted assuming it was similar, and since I wanted uninterrupted coverage due to ongoing medical issues.  

On 4/18/2024 I made a max contribution ($9300, I'm over 55) and have paid $11,705 in medical expenses YTD.  As I am now actively looking to renew or replace that plan, I discovered that my existing health plan for TY2024 was not in fact a high deductible plan.  What do I do to rectify this?  Do I reimburse myself for the $9300 contribution?  Do I also reimburse my HSA account to cover the medical expenses I paid this year from my HSA account?

[Opus 17 · Accepted solution]

You say you spent money but you don't give your ending balance.  If the ending balance is more than zero, it is assumed that the ending balance is made up of the ineligible funds, and will be subject to a penalty.

The first thing that will happen in Turbotax when you indicate that you did not have eligible coverage, is that the contributions will be added back to your taxable income (they are not tax deductible).  That's automatic and can't be changed.

Then, if there are ineligible funds remaining in the account, they are subject to a 6% penalty.  So if you spent all your account on medical expenses and your balance is zero, there will be no actual penalty.  If you had $5000 in the account, that will be subject to a 6% penalty.  If you have more than $9300 in the account, the $9300 will be subject to the penalty.

To avoid the penalty, you must remove the excess contributions.  This is a special procedure, not a regular withdrawal, so check with the bank.  The removal must be done before April 15, 2025.  You must also remove any interest or earnings that are attributable to the excess contribution (the bank will know to do this), and those earnings are reported as other miscellaneous taxable income on your 2024 return (even if the excess is removed in 2025).

If you leave the funds in the account and pay the penalty for 2024, you can apply them to next year's contribution limit and "use them up" that way.  For example, 2025's family limit is $8550 plus $1000 over 55.  Suppose you have the full $9300 as excess from 2024.  If you paid the penalty and didn't remove the funds, but you are eligible in 2025, you can contribute an additional $250 for 2025, and treat the 2024 excess as applied to 2025, and it won't be excess any longer. 

[AnnieMacGSP]

Great explanation, many thanks!