Editor's Note: This article has been edited to include more relevant information. This article was originally published on January 31, 2019.
A health savings account (HSA) can be a great way to save money for medical expenses and even for retirement. But they do have rules you have to follow in regards to how much you can contribute.
If you go over your contribution limits, that money is an excess contribution. There are a few ways to deal with excess contributions. No matter which option you choose, it’s always best to try to fix the mistake as soon as you realize it.
Benefits of a Health Savings Account
The IRS sets annual contribution limits because HSAs offer three main tax benefits:
- Your HSA contributions are tax deductible.
- If you invest your HSA money, the earnings grow tax-free.
- You can withdraw your HSA money tax-free when spending it on qualified medical expenses.
If you receive your HSA as a benefit from your employer, you can take it with you if you leave your job. So you own the account and can take it with you throughout your career. Even better, there is no deadline to use the funds you contribute in your HSA. You can save them for a big planned medical expense, or keep them growing until retirement if you want.
You may have noticed tax-advantaged accounts, like your 401(k), Roth IRA, or 529 plan, have contribution limits. Otherwise, folks could get away with major tax savings — more than the IRS would like. Your HSA is no different. Even when you get tax breaks, the IRS still puts limits in place and works to ensure everybody plays by the rules.
HSA contribution limits go by the calendar year. So even if you enrolled in your HSA mid-year, or your plan year runs on a different schedule, you are still subject to calendar year contribution limits. Limits change every year, so make sure you stay up to date and don’t reference limits from the previous year. The limits for 2021 are below.
If you are enrolled in your HSA the full calendar year and your health plan doesn’t change, it is pretty straightforward to understand your contribution limit. But there can be a few factors that make it trickier:
- Multiple sources contributing to your HSA. Anybody can contribute to an HSA, so if you have your employer, yourself, and a generous family member all contributing, you have to make sure to coordinate your efforts so you don’t go over the limit.
- Gaining or losing coverage mid-year. If you gain or lose coverage under a high deductible health plan (HDHP) during the year, you will change your HSA eligibility status. If you are not eligible for an HSA during the entire calendar year you have to either adjust your contributions accordingly or make sure you qualify under the last month rule. Either way, it’s important to be aware of your HSA eligibility and contribute accordingly.
- Changing plan type mid-year. The contribution limits are different for individual and family plans. If you got married during the year, or your spouse got other coverage and left your plan, you experienced a change in plan type. You have to make sure that you don’t go over the individual limit in the months you are an individual and vice versa for family plans.
No matter what situation you are in, it is a smart move to know your contribution limit every year, just like you would your income for the year, and stay on top of the contributions to your HSA.
Penalties for Excess Contributions
There are three consequences for making excess HSA contributions:
- 6% excise tax on the excess contribution
- Income taxes on the excess contribution
- Income taxes on any earnings the excess contribution made
It is important to be aware that excess contributions and earnings from those contributions are subject to income tax, particularly if your HSA is invested.
Fixing Excess Contributions
If you realize you have made excess contributions to your HSA it can feel like a big mistake. But the good news is that there are ways to fix it and move forward.
Option 1: Removing the Excess Contributions
This is by far the most straightforward option, and it is one that many people choose when they make excess contributions.
If you realize you have made an excess contribution before the tax year ends (usually April 15), take it out immediately. You can take out the excess contribution by making a request with your HSA provider, which may involve filling out a form or two. If you have been contributing to your HSA via payroll, you should also inform your employer. Once you take the money out it will be regular taxable income earned.
If you remove the excess contribution before the deadline for filing your personal income tax return, you won’t be subject to excise tax. If you remove it before the end of the calendar year, you typically won’t need corrected tax forms. If you remove it after the end of the calendar year, but before the end of the tax year, you won’t be subject to excise tax, but you may need corrected tax forms. If you remove it after the tax year has ended, you will be subject to excise tax for that year (and all other years you keep the excess contribution in your account).
Here’s a table to help remember the dates involved. In this example, we are assuming you made the excess contribution in the 2020 calendar year.
Option 2: Rollover the Excess Contributions to Next Year
This is an option that you should choose if you are certain you will be keeping a close eye on your HSA contributions in the future.
With this option you rollover the excess contribution in your HSA to a future year and pay excise tax for the intervening years. You will deduct the rollover on IRS Form 8889 when you are ready.
For example, say that I made an excess contribution of $100 in 2020. I decide to roll it over to 2021, so I pay $6 in excise tax in 2020, then report the $100 on Form 8889 in 2021. I will also make sure that I do not go over my contribution limit in 2021 with the rollover included.
Option 3: Do Nothing
We get it. You’re busy, and taxes can be a big headache. It may be tempting to ignore excess contributions and hope that nothing will go wrong, but this is a bad option.
If you do nothing, your excess contributions (and associated earnings) will be subject to income tax and excise tax in the year you made them. This alone may seem bad enough, but they will also be subject to excise tax every year until they are removed. That’s definitely a good reason to take action the moment you figure out you have excess contributions.
Monitor Your Contributions to Avoid Future Issues
HSAs offer a plethora of tax benefits, and they can be a great way to save money for medical expenses and for retirement. But they do come with some responsibilities, among which is making sure you follow contribution limits. Before you set up your HSA contributions for the year, take a look at the new IRS limits and make sure that all of your contributions will stay below that number. If your eligibility status or plan type is going to change throughout the year, make sure you are aware of how that impacts your limit. Doing some preparation and planning goes a long way when it comes to avoiding penalties when you contribute to your HSA.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.