If you've got coverage under a qualified high deductible health plan (HDHP) and are eligible to contribute to a health savings account (HSA), you probably already know that there's a limit on how much you can contribute each year, including contributions made by anyone else (like your employer) on your behalf.
In 2018, if you're HSA-eligible for the full year, the limit is $3,450 if your HDHP covers just yourself, or $6,900 if it also covers at least one other family member. On the surface, that's pretty straightforward: You know what the limit is, and you can either make a lump-sum contribution or spread your contributions out over the year (and you have until the tax filing deadline, around April 15 of the following year, to make some or all of your contributions).
A few scenarios...
There are situations that can make it more complicated, like becoming HSA-eligible mid-year, losing your HSA-eligibility mid-year, or enrolling in Medicare. There are rules that apply to HSA contributions in all of those scenarios, but if you don't know about them, you might inadvertently end up contributing more than the allowed amount to your HSA.
Maybe you already contributed the full-year amount and then end up switching to non-HDHP coverage before the end of the year. Or maybe you enrolled in Medicare and didn't realize that your HSA contributions needed to stop. So then what?
That second scenario happened to one of my family members a few years ago. He turned 65, but continued to work and continue to be covered by his employer's health plan, which happened to be an HDHP. He'd been enrolled in that plan for several years, and always made automatic contributions to his HSA, deducted from his paychecks.
When his Medicare coverage took effect, it was in addition to his employer-sponsored HDHP. And neither he nor his employer was aware that his HSA contributions needed to cease at that point.
Almost two years went by before he found out that his HSA-eligibility had ended when he enrolled in Medicare. He stopped his contributions at that point, of course, but what about the contributions he'd made since his Medicare coverage took effect?
He hadn't been using his Medicare benefits in that time period, but in order to retroactively cancel his Medicare (and wait until he retired to re-enroll), he would have also had to give back all of the Social Security benefits he'd received since turning 65, which obviously wasn't appealing.
So the only other option was to sort out the excess contributions that he had made to his HSA. First, he had to withdraw all of the contributions he had made since enrolling in Medicare, and he also had to withdraw the investment returns and dividends those contributions had earned during that time (the HSA custodian can help you figure out how much this is).
But then he had to pay an excise tax on the excess contributions and earnings for the prior year The details are in Publication 969, under "excess contributions." But, to give you an overview, you'd report earnings for the excess contributions under the "other income" section of your tax return. Then the excise tax is calculated using Form 5329.
For the current year's contributions, he was able to just withdraw the contributions — so they would no longer be deducted from his income when he filed his taxes — and then add the withdrawn investment earnings to his taxable income for the year.
But for the prior year's contributions and earnings, a 6% excise tax applied, in addition to having to include the withdrawn amount in his taxable income for the year. That was a one-time charge, because he withdrew all of the excess contributions as soon as he found out about the problem.
But the excise tax continues to apply to excess contributions and earnings if they're not removed from the HSA.
As with all tax-related scenarios, you'll want to consult with a tax adviser if you have questions about your own specific situation — both in terms of avoiding excess contributions in the first place, and how to sort out the situation if you find out that you've made excess contributions to your HSA.
But, because the excise tax continues to apply for as long as the excess contributions (and their earnings) remain in your HSA, the worst thing you can do is ignore the problem. It won't go away on its own, and it will continue to cost you. Sorting it out as soon as you realize the problem is your best course of action.
Tax Facts is a weekly column offering straight up, no-nonsense HSA tax tips, written in everyday language. Look for it every Tuesday, exclusively on the HSAstore.com Learning Center. And for the latest info about your health and financial wellness, be sure to follow us on Facebook and Twitter.