Q&A on Health Savings Accounts

For nearly two decades, Health Savings Accounts have steadily grown in popularity as a way to save for healthcare costs, create alternative investment opportunities, and reduce annual tax payments among other little-known benefits. And each year it seems we are having more-and-more discussions with clients with regards to HSA’s.

So, whether you’re crunching the numbers on this year’s tax return or just want to get ahead for next year, we’ve put together this Q&A to help answer some of the most common questions regarding Health Savings Accounts.

Q:  I just realized I did not max out my HSA contribution for the previous year. What can I do?

A:  You will need to write a check payable to the company that holds the HSA and mail it by the tax filing deadline, which is generally April 15th. Be sure to indicate on the check that the contribution is for the previous tax year. Monitor the account and confirm that the deposit is coded properly. You will receive a Form 8899 around May and you can also double-check the previous year’s total contribution. Alert your CPA if you are planning to do this and give her your 8899 when you receive it.

If you are making payroll deductions to your HSA through your employer, you will follow the same instructions above, as payroll deductions generally can’t be coded as prior-year contributions.

Additionally, adjust your current-year contributions to ensure that you max out by the end of this calendar year. It’s more tax advantageous to fully fund your HSA through payroll than to write a check as described above.

Q:  How do I invest my HSA?

A:  Most HSA custodians automatically put all contributions into a cash or money market investment. However, many firms also offer the ability to invest your HSA contributions into a designated menu of mutual funds, similar to a 401(k). Let us know if you have this option and we can make a recommendation on how to invest the account.

Other custodians, such as HSA Bank, also have the ability to transfer funds to TD Ameritrade and we can manage that account just like we do for IRAs or brokerage accounts.

Q:  What if my adult child is on my company’s health plan? Can he or she invest in an HSA?

A:  If your children are NOT claimed as dependents on your tax return but ARE covered under your employer’s high deductible health plan, they can each make contributions to their own HSA’s. And, because of a loophole in the tax law, they can each put the family maximum into an HSA, just as you and your spouse can put the family maximum into your own HSA's.

This also creates an amazing gift opportunity to give to your children – fully or partially funding your child’s Health Savings Account when she is in her 20’s would give her a great start towards growing a tax-free balance that can be used for future health care costs.

Q:  What if my employer contributes to my HSA?

A:  Keep in mind that the maximum HSA contribution for 2020 ($3,550 for self-only, and $7,100 for family coverage plus a $1,000 catch-up contribution for those aged 55 and older) INCLUDES any employer contributions. So, if your employer deposits $1,000 per year into your account, and you have family coverage, you can only contribute $6,100 for that year. This is unlike a 401(k)-matching contribution, where your maximum contribution amount is generally not affected by the amount deposited by your employer.

Q:  Should I take advantage of the one-time transfer from an IRA to my HSA?

A:  Generally speaking, no. There is a special rule that allows people to transfer that year’s maximum contribution amount from an IRA to their HSA without taxes or penalties. It was created in order to “jump-start” HSA accounts for people who didn’t have available cash to start making deposits and needed to access the funds to pay for health care costs. It can only be done once per a taxpayer’s lifetime and you must remain eligible for an HSA for at least 12 months after making the rollover contribution.

As long as you can fund regular health-related expenses from your cash flow, there is no reason to make this kind of transfer. You will find a better tax benefit by keeping your funds in your IRA and also fully funding an HSA. But if there’s a year where your cash flow doesn’t allow you to fund an HSA, this would be a way to keep the account balance growing. But whatever you do, don’t fund an HSA from a Roth IRA. Use pre-tax funds from a traditional IRA.

Q:  What’s the deal with the “last month” rule?

A:  Let’s say you switched jobs mid-year and decided to take our advice and sign up for an HSA-eligible health insurance plan. As long as your eligibility to contribute to the HSA plan begins on or before December 1st of a given year, you can make the entire year’s contributions to your HSA. Your contributions are not prorated to that one month.

You must remain on an HSA-eligible plan for at least 12 months after making the full year’s contribution as described in this example. Otherwise, you may be penalized for making an excess contribution to the account. This is a complicated area, so please consult with a tax advisor before taking advantage of the “last month” rule.