The federal government recognizes the strain of healthcare costs on Americans. To help ease this burden they created tools like Health Savings Accounts (HSAs), which allow healthcare consumers on high deductible health plans to set aside tax-free money to pay for medical expenses. But, as with any tax-advantaged financial tool, there is a limit on how much account holders can contribute to their HSAs every year. If you go over the annual contribution limit, the IRS can penalize you. Fortunately, there are two different ways to handle HSA excess contributions which can help you avoid paying a penalty.
What is an HSA Excess Contribution?
In 2022, the maximum contribution limits for HSAs were $3,650 for individuals and $7,300 for families. Account holders age 55 and above can contribute an additional $1,000 per year as a “catch-up” contribution. These limits are based on inflation, and generally increase by moderate amounts every year.
To maximize your tax savings, you want to contribute up to the limit, but no more. Any amount over the limit is an HSA excess contribution.
What is the Penalty?
When you surpass the maximum contribution limits, the penalty you pay depends on the amount of the excess contribution. Generally, the IRS penalty equals 6 percent of your excess contributions. For example, if you have a $100 excess contribution, your fine would be $6.00. If you contributed $1,000 over, it would be $60.
This penalty is called an “excise tax,” and applies to each tax year the excess contribution remains in your account. This means you will incur the 6 percent excise tax every year until you remove it from the account or apply it to a future year.
What Causes HSA Excess Contributions?
Most people contribute the same amount to their HSA on a weekly or monthly basis, or with each paycheck. Simply divide the contribution limit by the number of contributions to figure out how much you can put in. However, there are some circumstances that could put you over the limit:
- Multiple contributors. Anyone can contribute to your HSA account, including a friend, a relative or your employer. Since the annual limit applies to the total sum, you have to also keep track of contributions made by others or risk going over the limit. This is especially important if your employer makes contributions.
- Incorrect calculations. Even with digital calculators, people can make mistakes. If you miscalculate the size of your regular contributions, you can end up going over the limit. It pays to double-check your calculations each pay period to make sure you’re still on target. You can always adjust your contributions at any time for any reason throughout the year.
- Irregular contributions. HSA contributions don’t have to be on a regular basis. You can contribute any time you want, which some people prefer over having the contribution taken out of their paycheck. Others may vary the size of their contributions based on their cash flow at any given time. If you take one of these approaches, be sure to track your contributions closely.
- Eligibility issues. Most people automatically calculate their regular contributions based on the assumption of a year’s eligibility. But if you’re new to your company, you may have an introductory period before you become eligible to open an HSA account. Or, perhaps you contributed a large part of the maximum limit early in the year (called front-loading) and then lost your HSA eligibility before the end of the year. Either situation makes you eligible for less than the full year, which can cause an HSA excess contribution. Contribution limits can also change depending on an updated coverage status, due to marriage, divorce, new child, etc.
How to Correct HSA Excess Contributions
As mentioned, the IRS provides two ways of correcting over-contributions. The first involves removing the excess from the account in the tax year that it occurred. This means you have until your tax due date to make the correction. You must also remove any earnings on your excess contributions. The second method involves applying your HSA excess contributions to the following year.
Removing Excess Contributions
For most people, the removal method will be the preferred option. It is relatively simple to do, and it takes care of the problem once and for all. It allows you to avoid paying a penalty as long as three criteria are met. You must:
- Withdraw the excess contributions no later than the due date of your tax return for the year the contributions were made. These withdrawals will be considered taxable income.
- Take out any income earned on the withdrawn contributions during the year they were made. This will also be taxable income.
- Include the earnings in “Other Income” on the tax return for the year you withdraw the contributions and earnings.
You can withdraw some or all of the excess contributions, but you will have to pay the excise tax on any that you leave in the account.
When removing excess contributions from your account, you must inform your HSA trustee. If you don’t, they won’t know to do it. The excess funds that were withdrawn will be listed on Form 1099-SA as a distribution, in Box 1, for the tax year in which the distribution was taken. Earnings on excess contributions withdrawn will be in Box 2 and included in Box 1. Form 5498-SA will report the market value of your HSA at the end of the calendar year, the total contributions made within the calendar year, and the total contributions for the tax year through the tax filing deadline, typically April 15. The account owner should retain Form 5498-SA for record keeping purposes, but is not required to submit it to the IRS.
Future Year Option
The second way to avoid the HSA excess contributions penalty is through the “future year method.” It involves deducting some or all of your HSA excess contributions and applying them to a future year. The IRS does not allow you to apply more than you have in excess. It’s also important to keep in mind that moving the excess to the following year counts towards the future year’s annual contribution limit.
The future year method is more complicated than the removal method, especially if you have earnings from any of the excess contributions. If you opt to roll forward some, but not all, of the excess contributions, you will owe the 6 percent tax on any that are not applied to a future year. Both methods must be completed before your tax filing deadline or you will be charged the excise tax. Consider filing an extension on your taxes to give you more time.
This article does not constitute tax or legal advice and should not be relied upon as instructions to complete your State or Federal tax return. If you have specific questions on how to report excess HSA contributions or distributions on your tax return, please consult a qualified tax or legal advisor.
DataPath, Inc. is a leading provider of HSA management solutions for third party administrators.