Withdraw from HSA that should have never existed

Question

I have an HSA that apparently I was ineligible to hold due to the fact that I had a secondary insurance. Only my employer made contributions to it, I did not.

My employer is going out of business and I will be responsible for the account maintenance starting in May.

I understand that if I withdraw the money not for a covered medical expense it is subject to income tax and a penalty fee.

Is this my best option if I currently have no expenses that would be c0vered? Is there any risk or repercussions that I was technically not eligible to open the account in the first place?

Answer 1

Assuming that your employer made these contributions in 2017, you should be able to withdraw these funds using an excess contribution withdrawal. You’ll still have to pay income tax on the funds, but you’ll avoid the 10% penalty. To do this, contact the HSA bank and tell them you want to do an excess contribution withdrawal of everything that was contributed in 2017. In addition to that amount, they should also withdraw any earnings (interest) that was generated from those funds. On your 2017 tax return, you need to add the entire amount as “Other Income” so you can pay tax on it. You have until April 15, 2018 to do this, so you’d better hurry. If you have already filed your 2017 tax return, you’ll need to file an amended return.

If you decide just to leave the money in the HSA, you’ll pay a 6% penalty each year until you finally withdraw the money and pay the tax.

If your employer also contributed in 2018, you’ll need to do an excess contribution withdrawal for those funds as well. The deadline for that will be April 15, 2019 (although I recommend doing it as soon as possible), and that will get reported on your 2018 tax return.