Overcontributing to a Health Savings Account (HSA) can happen, typically when you change jobs. This can happen if your new employer is not informed of the contributions you’ve already made via your previous employer, provided their payroll software has the capacity to accommodate this information. It’s worth noting that excess contributions to an HSA are unlikely with a single employer, as the payroll software should automatically halt contributions once the maximum limit is reached.

Another reason to have excess contribution is that you are ineligible to contribute HSA because you are covered by your spouse’s insurance, or your spouse has a general purpose Flexible Spending Account (FSA) which can potentially cover you regardless whether it actually covers or not. Please see HSA/FSA Contribution Rules for Married Couples to see your eligibility to contribute the HSA.

For one reason or the other, if you have overcontributed your HSA, there are options to rectify the situation.

Option 1: Treat spending as withdrawal (timely correction).

If you had spending from the HSA before the filing deadline (including extensions), you can treat distributions as a withdrawal of the excess.

For timely correction, the IRS requires that you withdraw the excess contribution plus earnings (“such distribution is accompanied by the amount of net income attributable to such excess contribution.” per IRC Sec 223(f)(2)).

“If the excess contribution isn’t included in box 1 of Form W-2, you must report the excess as “Other income” on your tax return.” (IRS Publication 969).

You also need to pay tax on the earnings (“Any net income described in clause (ii) shall be included in the gross income of the individual for the taxable year in which it is received.”, IRC Sec 223(f)(2)).

However, you do not pay 6% excise tax as the excess contribution has been timely corrected.

Step by step instructions:

  • Calculate the distribution plus earnings:
    • c = amount of the contribution.
    • b1 = balance after contribution.
    • b2 = balance before distribution.
    • e = excess contribution.
    • d = distribution = \(e(1 + \frac{b2-b1}{c})\).
  • Report the excess contribution and earnings withdrawn on Form 8889, line 14b (for tracking qualified medical expenses).
  • Report the excess contribution (if not already included in W-2) and earnings (always) as “other income” on your tax return.
  • Report the excess contribution withdrawn on Form 5329 to avoid the 6% excise tax.

If you do not have enough spending to withdraw the excess contribution plus earnings, the excess is not considered as withdrawn, and you will need to follow option 2, 3, or 4. The excess contribution is either corrected or not corrected, there is no partial correction.

Option 2: Timely correction: actual withdrawal (timely correction).

The process is the same as Option 1 except that you need to contact your HSA custodian to have the excess plus earnings withdrawn. This is the most straightforward option, but it may also be the most time-consuming, and sometimes costly as some HSA custodians charge a fee for the service.

Option 3: Rollover to next year (untimely correction).

If you have missed the chance, or simply do not want to go through the trouble of contacting the HSA custodian, another option is to simply let the excess stay in your account for the current year, pay a 6% excise tax, and treat it as part of your contribution for the next year. Be sure to adjust your next year’s contribution amount so that the total does not exceed the limit1.

Note: You will also need to add the excess contribution (excluding earnings) to your current year’s income. You can then deduct the excess in the following year, up to the amount that fits within the maximum limit.

For example, let’s say you contribute $3,950 to your HSA in 2023, but the maximum contribution limit is $3,850. You would have $100 of excess contributions. If you choose to rollover this amount to the next year, you would pay a 6% excise tax on the excess, which is $6. You would then add the $100 to your 2023 income. In 2024, you could deduct $100 from your taxable income.

Step by step instructions:

  • Let the excess contributions stay in your HSA account.
  • Pay a 6% excise tax on the excess contributions.
  • Add the excess contributions (excluding earnings) to your current year’s income.
  • Adjust your next year’s contribution amount so that the total does not exceed the limit.
  • Deduct the excess contributions in the following year, up to the amount that fits within the maximum limit.

Option 4: Actual withdrawal (untimely correction)

If you have discovered the errors late, and cannot withdraw the excess contribution by spending it out, you can always contact your HSA custodian to withdraw the excess.

You will pay 6% excise tax on the excess contribution that remained on the account “as of the close of the taxable year” (IRC Section 4973(a)), that is December 31st, not the tax filing deadline for untimely correction.

You will also need to pay regular tax on the excess contribution if not included in W-2 (excluding earnings) for the year of the contribution.

Which option is right for you?

The correct answer is: none of the above. The best option is not to have an excess contribution, but things happen, so I hope this post provides information to allow you to make a decision that can minimize your cost in both of time and dollars.

PS:

When the contributions were initially allowed when made (you were eligible), but later become ineligible under the testing period rule, these are not “excess contributions” - they were proper contributions at the time, but now must be included in income due to loss of eligibility. Unlike excess contributions, these amounts do not need to be removed from the HSA - they only need to be added to income.

Footnotes:

1 IRS Publication 969 states:

You may be able to deduct excess contributions for previous years that are still in your HSA. The excess contribution you can deduct for the current year is the lesser of:

  • (1) Your maximum HSA contribution limit for the year minus any amounts contributed to your HSA for the year, or
  • (2) The total excess contributions in your HSA at the beginning of the year.

References:

  1. Instructions for Form 8889.
  2. Instructions for Form 5329.
  3. Publication 969 - Health Savings Accounts and Other Tax-Favored Health Plans.
  4. IRC Section 223.
  5. IRC Section 4973.
  6. HSA/FSA Contribution Rules for Married Couples.