Excess HSA Contributions? Contributing too much to your HSA can lead to tax penalties, but there is an easy fix!
Health Savings Accounts, or HSAs, are a terrific way to stash away pre-tax money for retirement. Even though HSA funds can only be used on medical expenses, they can accumulate over time into a powerhouse asset that can protect your other accounts from the cost of hearing aids, hospital bills, nursing homes, and much more.
But contributing too much to your HSA can lead to stiff tax penalties. Fortunately, its an issue that is easily fixed.
This guide will not only explain how to remove an excess HSA contribution, but also some of the common reasons excess deposits are made, and the specific tax penalties you can face if they aren’t corrected.
What is an Excess HSA Contribution?
The IRS sets the maximum annual HSA contribution at $3,650 for individuals and $7,300 for families in 2023; [These numbers change from year to year]. Contributing more than this is known as an excess HSA contribution.
Excess HSA contributions can lead to tax penalties that will decrease the overall savings power of your HSA.
Common Causes of Excess HSA Contributions
Most people make contributions to their HSA on a monthly or bi-weekly basis, as a deduction from their paycheck. If you do the math correctly, then determining your monthly contribution amount should be as easy as dividing the annual limit by 12.
However, there are some situations that make excess contributions a bit more common, including:
- Multiple Contributors. Anyone can make contributions to your HSA, including friends, relatives, and most commonly, your employer.
- Bad Math. Math mistakes are very easy to make. Incorrectly dividing the year into HSA contributions can lead to much more in your account than you should actually have.
- Irregular Payment Schedules. There is no rule that says you have to contribute with each paycheck. Some people make 1 or 2 contributions throughout the year. If you don’t keep track, it can be easy to make a mistake.
- Change in Eligibility or Coverage Status. Your employer-sponsored HSA eligibility might change based on your status. In addition, getting married, divorced, or having a child can change your annual maximum contribution.
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What is the Penalty for Excess HSA Contributions?
Excess HSA contribution penalties depend on the amount of excess funds that are in your account. In most cases, the IRS penalty would equal 6% of your total excess contributions. This penalty is known as an excise tax, and is applied annually for each year that the excess contribution is in the account.
Excess HSA Contribution Example
Let’s say you contributed $2,000 above the annual HSA contribution limit. As long as that money remains in your account, you will be forced to pay a tax penalty of 6%, or approximately $120, every year.
How do I Remove Excess HSA Contributions?
There are two primary ways to correct an excess HSA contribution. The first is to remove the excess funds in the same year they were made, before the tax deadline. The second is to apply your excess contributions towards the next year’s amount.
Here’s a closer look:
Method One: Remove Your Excess HSA Contribution Before the Tax Deadline
If you’re paying attention, then it’s possible to correct the mistake before the IRS even notices. Simply remove the excess amount from your account before Tax Day, and you will not incur a penalty. However, these withdrawals will count as taxable income.
You will need to make sure that you report these withdrawals on Form 1099-SA, or tell your HSA administrator to do so.
IMPORTANT: You must also withdraw any interest that was earned on the excess funds.
Method Two: Apply Your Excess HSA Contribution to a Future Year
If you miss the tax deadline for correcting your HSA contribution, you may be able to deduct it from the following year. In other words, the total excess amount in your account at the beginning of the year can be deducted from that year’s contribution.
This is slightly more complicated, and requires the use of Form 5329 to report the deduction. Consult with your HSA administrator if you have any questions about how to get this done.
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