How Do Breaks in HSA Eligibility Affect Your Establishment Date?

What happens to your opportunity to reimburse qualified expenses incurred during a period that you're not eligible to open and fund a Health Savings Account?

It's not uncommon for employees to toggle during their working years between enrolling in HSA-qualified and traditional medical coverage, depending on which plans each new employer offers. A gap during which you're not HSA-eligible may affect your ability to reimburse tax-free expenses with dates of service during that period.

Let's break down the issue to minimize confusion and maximize tax savings.

Establishing a Health Savings Account

You can't reimburse tax-free any expenses that you incur before you establish a Health Savings Account. The Internal Revenue Service issued guidance in 2007 noting that a Health Savings Account is a trust and thus follows the trust law of the state that governs the account when determining the date of establishment (see Q&A 38 here). In most cases, state law requires a trust to hold an asset before it's established. Therefore, in most states, the date of establishment of a Health Savings Account is the date that the first deposit is recorded in the account. All qualified expenses with dates of service on or after that date are qualified for tax-free reimbursement.

Note: Utah amended its trust law in 2009. Owners whose Health Savings Accounts are governed by Utah law can establish their accounts retroactively back to the date that they enroll in an HSA-qualified plan if they fund the account by the due date of their tax return for that year.

Example: You begin coverage on an HSA-qualified plan effective April 1, 2023. You can place your first deposit into the account as late as April 15, 2024, and reimburse all qualified expenses that you incur on or after April 1, 2023.

There is a caveat to Utah law. You can establish your account as stated under Utah law, but you can't reimburse tax-free your qualified expenses for dates of service before you meet the federal eligibility requirements to fund your account.

Example 1: Your HSA-qualified coverage is effective April 15. Eligibility is determined as of the first day of a month, so you're not HSA-eligible under federal law until May 1. You can establish a Utah-governed Health Savings Account retroactive to April 15, but you can't reimburse tax-free any qualified expenses that you incur prior to May 1.

Example 2: Your HSA-qualified coverage is effective Jan. 1. But your spouse's general Health FSA has a grace period through March 15, and he carries a balance into the grace period. You're not HSA-eligible during that grace period. You can establish a Utah-governed Health Savings Account as of Jan. 1, but you can't reimburse tax-free any qualified expenses with dates of service prior to April 1.

No Deadline for Reimbursement

HSA owners face no deadline to reimburse qualified expenses tax-free. Once you open and fund your Health Savings Account, you can reimburse tax-free all qualified expenses, even when you're no longer HSA-eligible, until you exhaust your balance or die. This feature makes Health Savings Account a particularly valuable vehicle in which to save for future qualified medical expenses.

Example: You established your Health Savings Account as of Jan. 5, 2010, and accumulated a balance of $19,000 before you lose your eligibility to make additional contributions as of Jan. 1, 2024 (perhaps due to enrollment in Medicare or other employer coverage). You can reimburse any expenses that you incurred on or after Jan. 5, 2010, including future qualified expenses, until you exhaust your balance.

Be sure to retain receipts to preserve your opportunity to reimburse tax-free those qualified expenses that you don't pay immediately from your Health Savings Account (perhaps because you want to retain your balance to grow tax-free through investments).

Establishment Date and Breaks in Coverage

Over the course of four decades or more of employment, it's not unusual for a typical worker to be covered by a half dozen or more employer-sponsored medical plans. (After years of unbroken coverage, I've been enrolled in three plans offered by three different insurers during the past nine months.) And since not all employers offer HSA-qualified plans (yet!), you may have periods when you're not covered by an HSA-qualified plan, followed by periods when you are. In these cases, the establishment date can get tricky.

Example: You're HSA-eligible and fund your account. You switch employers and don't have access to an HSA-qualified plan. You spend down your Health Savings Account balances. Five years later, you become HSA-eligible again and start funding your account. What is your establishment date?

Let's break down this example. We need dates and balances to determine whether you can incur expenses that you incurred during your non-eligible period if you spent your full balance while you weren't eligible to make additional contributions.

You maintained a balance throughout. This is your best scenario. If you never exhausted your prior balance, your establishment date reverts to the date that you established your original Health Savings Account.

Example: You funded your Health Savings Account between Jan. 1, 2014, and Dec. 31, 2020. You then lost eligibility. You reimbursed some - but not all - of your qualified expenses tax-free since then and maintained a balance. You become HSA-eligible again effective Jan. 1, 2023. Your establishment date reverts to 2014, so that you can reimburse tax-free any qualified expenses that you incurred but didn't reimburse between then and the present with contributions to your new Health Savings Account.

You exhausted your balance within 18 months of establishing your new account. This scenario is also ideal. Under federal tax law, if the gap between exhausting prior balances and establishing a new Health Savings Account is 18 months or less, your establishment date reverts to the date that the original Health Savings Account was established.

Example: Same eligibility as above. You exhaust your balance in the first Health Savings Account on Sept. 8, 2021. Because you establish your new Health Savings Account within 18 months (the span is 16 months), you can reimburse tax-free all qualified expenses that you incurred between Sept. 8, 2021, and present with new contributions into your new account.

You exhausted your balance more than 18 months before you establish a new Health Savings Account. In this case, you can't reimburse tax-free any expenses that you incurred prior to establishing your new Health Savings Account.

Example: You funded a Health Savings Account between 2010 and 2015. You then enrolled in other coverage and spent your full balance by 2017. You become HSA-eligible again in 2023 and establish a new Health Savings Account. You can't reimburse tax-free any qualified expenses that you incurred before you establish your new account.

Be Proactive to Retain Your Original Establishment Date

Unless you know that a break in Health Savings Account eligibility is permanent (for example, you enroll in Medicare), be sure to preserve a balance, however small, in an existing account. Find a Health Savings Account with no monthly fee, or work with an administrator who allows you to pay any fees with personal funds rather than automatic withdrawals from your Health Savings Account. This way, you ensure that your establishment date reverts to the original date when you open a new account.

Become a Hero to Your Child

Here's another tip that I adopted.

It's not unusual for children to remain covered on a parent's plan (up to age 26) as they establish permanent employment and qualify for their own employer-sponsored coverage. When your covered adult child no longer qualifies as your tax dependent, the child can open and fund her own Health Savings Account. As long as that account has a balance, if the child opens a Health Savings Account at any point in the future, her date of establishment will revert to the date that the original account was established.

Example: Your child ceased to qualify as your tax dependent in 2013. You open a Health Savings Account for the child and deposit $100 on May 6, 2013. The child enrolls in her employer's Health Savings Account program effective July 1, 2023. She can fund her new account and reimburse tax-free any qualified expenses that she incurred May 6, 2013, or later. She's already paid these expenses. If she maintained records (example: the insurer's list Explanation of Benefits for each year, showing the amount of out-of-pocket expenses met), she can make a large deposit into her account (up to the annual limit, for more than one year if necessary) and immediately reimburse herself for those expenses. Voila! Instant tax savings and an immediate return of the contribution in the form of a tax-free reimbursement.

The Bottom Line

You can always reimburse tax-free all future qualified expenses if you maintain a continuous balance (or spans of zero balance that don't exceed 18 months) between periods of eligibility to fund a Health Savings Account. If there's any possibility that you'll regain your eligibility in the future, be sure that you keep a balance - however minimal - and retain receipts (at least for big-ticket items). You may be able to save thousands in future taxes by retroactively reimbursing expenses with contributions to a new Health Savings Account.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.