Managing Your Health Savings Account during Life Transitions

You have a Health Savings Account. And your life has taken a turn for the better or worse. Your account can help you during the transition. Learn how.

A Health Savings Account is a lifetime account. Once you open and fund it, the account remains active for the rest of your life (or until you deplete the balance and are no longer eligible to contribute). Because your Health Savings Account is not tied to a job, an employer, or even a particular family situation, you can continue to benefit even when you lose your eligibility to deposit additional funds.

This week: We look at how you can leverage your Health Savings Account to enhance your finances during job and family transitions.

Next week: We focus on one specific transition period - retirement and death - and how your Health Savings Account can be a dependable financial partner during this period.

Job Change

A change of employers is a major source of leakage in employer-sponsored retirement accounts. Many employees choose to cash out their 401(k) deposits - even at the risk of taxes and penalties for premature withdrawals - rather than roll over the balances into a new employer-sponsored plan or an Individual Retirement Arrangement.

Avoid that mistake with your Health Savings Account balances.

Your first action is to determine whether your new company offers an HSA-qualified plan (you may have even made this a requirement of the new position). If it does and you enroll and fund your account, you'll probably have a new Health Savings Account administrator. (Alternatively, if it's the same one you're using, find out how to attach your account to your new employer in the administrator's system.) You can begin to fund the account immediately (or at the end of the benefits waiting period).

Learn the company's contribution policy. Does it deposit a set amount into employees' Health Savings Accounts, or does it offer a match that requires you to contribute to claim the employer money? It shouldn't really matter, as you'll want to start payroll deductions immediately

Loss of Job

If you continue coverage on your group plan by exercising your COBRA continuation rights, you can keep funding your Health Savings Account. Your eligibility to contribute isn't tied to your employer, employment in general, or earned income. If you enroll on a spouse's or parent's coverage or purchase coverage in the nongroup market and that coverage is HSA-qualified, you can continue to fund an account.

Your list of expenses qualified for tax-free withdrawals now includes medical premiums if you're collecting unemployment benefits or paying COBRA premiums. It's important to consider temporary job loss and the cost of coverage when determining how much to fund your Health Savings Account when you're working. Your balances are a source of premium funds during perhaps a time of loss of income and allow you to enjoy the same tax savings on premiums (tax-free) as your pre-tax premium deductions while you were working.

If you're continuing coverage and paying the premium yourself, be sure to deposit your money into your Health Savings Account (up to your contribution limit) and pay your premium through the account, rather than using personal funds. Enjoy the tax savings.

If you have a gap during which you're not covered by an HSA-qualified plan but enroll in one by Dec. 1, you can make a full year's contribution by leveraging the Last-Month Rule. This provision allows anyone who's HSA-eligible by Dec. 1 to fund her account up to the statutory limit that year, provided that she remains HSA-eligible through the end of the following calendar year.

Example: You lose your job June 30, 2023, after depositing $1,925 into your Health Savings Account. Your spouse adds you to his non-HSA-qualified plan effective July 1. You find a new job and enroll in a self-only HSA-qualified plan effective Oct. 15, 2023. You can contribute up to $3,850 total (it would have been $4,850 if you were age 55 or older) in 2013. You can contribute for November and December ($641.66 total). Or you can contribute for July through December (up to $1,975) by using the Last-Month Rule. But you must remain HSA-eligible through December 2024 if you contribute more than $2,566.66, the prorated amount for January through June and November through December - the eight months during which you were eligible).

Expanded Family: Marriage and Birth/Adoption

When you cover only yourself, your contribution limit is the statutory ceiling for self-only coverage, or $3,850 in 2023 (increasing to $4,150 in 2024 due to inflation). But when you add another family member - a spouse, a domestic partner, or a child - your limit nearly doubles, to $7,750 in 2023 (and $8,300 in 2024). By fully funding your account as your family size increases, you can shelter more of your income from federal and state income, and federal payroll, taxes. At a 30% combined tax rate, the extra $3,900 by which you can reduce your taxable income puts an additional $1,170 in your pocket (or your Health Savings Account).

If both you and your spouse are eligible to fund a Health Savings Account, you can each open an account and split the $7,750 maximum contribution between the accounts as you choose. In most cases, it will make sense for the spouse whose employer sponsors the medical plan to contribute through pre-tax payroll deductions, thereby gaining the additional tax savings by not paying federal payroll taxes.

Your children who are tax dependents don't meet the requirements to fund an account, so they won't enjoy any tax savings or have an opportunity to build a medical emergency account.

If your contract includes a domestic partner or an adult child, the situation gets interesting. They are covered on a family plan, so the family contribution limit applies to them. They're not married to another person on the medical plan, so they can contribute a full family contribution into their own Health Savings Account. Probably. The Internal Revenue Service has never officially endorsed this position, but the industry relies comments made by an IRS agent in 2010 (these were personal views based on the person's understanding of the law, not a reflection of IRS policy) indicating that family members in this situation could fund their accounts to the family limit.

You can reimburse your new spouse's and newborn or adopted children's qualified expenses tax-free, even if you built your balance and then stopped contributing prior to the marriage, birth, or adoption. Family members need only be a spouse or tax dependent at the time the service is incurred - not when the funds are deposited into the Health Savings Account - for you to make tax-free withdrawals for qualified expenses.

Divorce

Divorce can be devastating financially to the couple whose lives and finances are untangled through the courts. Fortunately, Health Savings Account rules provide some relief.

A Health Savings Account is another asset owned by one party (but not both parties - Health Savings Accounts, like retirement accounts, are never jointly owned by spouses) in the divorce. A judge can order the account owner to divide her balances, just as with any other asset. In this case, the receiving spouse can open his own Health Savings Account - even if he's not otherwise eligible - and receive a portion of the spouse's balance tax-free. The receiving spouse then manages the account as any other owner does - contributing additional funds if eligible, making tax-free withdrawals for qualified expenses, paying taxes and penalties on any withdrawals for non-qualified items and services, and reporting activity annually on his personal income tax return.

You can't reimburse tax-free any expenses incurred by your ex-spouse - not even qualified items and services - once you begin the legal proceedings. But you can reimburse tax-free any qualified expenses that he incurred prior to that date. And he can reimburse his own qualified expenses tax-free from his new Health Savings Account.

The Bottom Line

Some life transitions are exciting and represent new fulfilling chapters in our lives. Other transitions close doors, shatter dreams, and change our outlook on life. Regardless of the short-term or long-term joy or angst that these changes produce, your Health Savings Account can help you manage certain aspects of the transition.

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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.