Only a HSA Plan Enrollees' Expenses Can Be Reimbursed Tax-free? Nope!

Who's covered on your HSA-qualified plan and whose expenses you can reimburse tax free are different.

Relationships matter. And that statement is rarely more true than when it refers to family members whose expenses you can reimburse tax-free from your Health Savings Account. It's an important concept to understand if you want to maximize your tax savings and remain in compliance with federal tax law.

A key point of confusion among Health Savings Account owners is the concept that they can't make tax-free distributions from their accounts for some family members' qualified expenses, even if the family member is covered on their medical plan. And they can reimburse qualified expenses incurred by some family members who aren't enrolled in their medical coverage.

Eligibility to Enroll

Eligibility to enroll in medical coverage is determined by a number of entities: Federal and state governments, insurers, and employers. They determine who can and can't be covered, and under what circumstances.

For example, federal law requires that children under age 26 be permitted to remain on a parent's plan. That's true even when the child is no longer a full-time student, is no longer a tax dependent, and can enroll in an employer's group plan or qualify for advance-premium tax credits to purchase her own nongroup coverage at little or no cost. The child can even be married and remain on the parent's plan until age 26.

States, who are the primary regulators of medical coverage, have their own rules. California, for example, recently passed a law permitting residents enrolled in nongroup coverage to add one or more parents to their plan if the parent is the policy owner's tax dependent (living with the adult child and relying on that child for more than 50% of the parent's support). For decades, Massachusetts has required coverage for an ex-spouse until either party remarries.

Insurers and employers have some latitude as well. A common example is coverage for domestic partners. Federal and state law don't address this situation (though federal law views these relationships differently from marriages when assessing taxes).

Bottom line is that a variety of rules and regulations issued by a number of parties determines who can and can't be covered on a medical plan.

Expenses Eligible for Tax-free Reimbursement

In contrast, one entity alone - the federal Internal Revenue Service - determines whose expenses can be reimbursed tax-free from a Health Savings Account. The federal tax code limits tax-free withdrawals to qualified expenses incurred by:

1. the Health Savings Account owner,
2. her spouse (an official marriage is required), and
3. her tax dependents

Note what's missing in this list: any reference to coverage on an HSA-qualified plan or eligibility to open and fund a Health Savings Account. That's not an oversight. No one in the family is required to be enrolled in HSA-qualified coverage or to be eligible to fund a Health Savings Account for the account owner to withdraw funds tax-free to pay for those family members' qualified expenses.

When This Situation Expands Options

The distinction between being enrolled on a Health Savings Account owner's medical plan and the owner's ability to reimburse your qualified expenses tax-free is important. Here are two examples of situations in which an account owner can reimburse tax-free another family member's qualified expenses, even though the family member isn't enrolled on the owner's medical plan:

Example 1: Peter and Gina's children are grown. They each enroll in self-only coverage through their employers because their share of premiums for two self-only plans is less than their cost for family coverage. Peter enrolls in HSA-qualified coverage and funds his account. Gina enrolls in a traditional PPO plan. Peter can reimburse Gina's qualified expenses because she is his spouse - even though she's not enrolled on his plan.

Example 2: Juan, a widower in his 70s who's enrolled in Medicare, marries Rosalee. Juan saved more than $30,000 in his Health Savings Account during his working years. He can reimburse Roselee's qualified expenses tax-free from his account, even though he's no longer eligible to contribute and he never covered her on his medical plan.

Health Savings Account owners need to ignore coverage and focus on family relationships as they determine whose qualified expenses they can reimburse tax-free from their accounts.

When This Situations Reduces Options

Conversely, these rules can restrict tax-free reimbursement of some family members' qualified expenses, even when the person is covered on the family's medical plan.

Example 1: Diana's 24-year-old son Gabe remains enrolled on her medical plan, but he's working as a software engineer in another state and no longer qualifies as his tax dependent. Diana can't reimburse any of Gabe's qualified expenses tax-free from her Health Savings Account because he's no longer her tax dependent.

Example 2: Pam and Beau have been in a committed relationship for more than two decades. But for personal reasons, they've never married. Pam's employer allows domestic partners on the company medical plan. Even though Beau's on her plan, Pam can't reimburse his qualified expenses tax-free because they're not married (and Beau doesn't qualify as her tax dependent, for example due to disability).

Health Savings Account owners should have their antennae fine-tuned to family situations such as a domestic partner, ex-spouse, or adult child who no longer meets the definition of a federal tax dependent.

The Bottom Line

Health Savings Account owners must understand the distinction between

1. Who can enroll on the medical plan, and
2. Whose qualified expenses can be reimbursed tax-free from a Health Savings Account

In many cases, the lists are identical. But differences do exist, particularly with re

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