Tag Archives: Contributions

HSA Contribution Limits If Your Health Insurance Changes Mid Year

This post is based on a great question that came from an HSA Edge reader. Feel free to email any questions you may have to evan@HSAedge.com

We all know that our Health Savings Account has a contribution limit (2014 = $3,300 / $6,550), a maximum amount of tax free contribution that cannot be exceeded during the year. This is all fine and dandy assuming you start the year with an HSA plan and end the year with the same HSA plan. But what if your health insurance changes mid year? How does this affect your HSA? It turns out, changing your health insurance during a fiscal year can have an impact on how much you can contribute. If not followed properly, this can lead you to over contribute, causing painful penalties or taxes.

Below are 3 scenarios that show how changing your health insurance affects your contributions:

1) Sign up for HSA eligible insurance during the year

If you sign up for an HSA eligible health insurance plan during the year, you are on the right track to open a health savings account and begin contributing. You are allowed to make full contributions for a year if you are covered by HSA eligible health insurance on December 1st of that year. This is explained in detail in the post on the Last Month Rule. The summary is that when you start a new HSA eligible health insurance plan, you can contribute up to the maximum contribution limit during the first year if you had coverage on the first day of the last month of the year. In other words, if you have a plan opened by December 1st, you can contribute up to the max.

However, this is enforced by the Testing Period, which says that if you are going to take advantage in that first year and contribute more than your pro-rata share, you have to stay on an HSA eligible plan for a corresponding time during that subsequent year. If not, you have in fact over contributed and penalties / taxes occur. Thus, if you are going to sneak in a full year contribution during your first year on an HSA plan, make sure you are not just a flash in the pan and are planning on staying on that plan for a while.

2) Switch health insurance plans to other HSA eligible plan mid year

This is quite simple: if you change health insurance plans, and both are HSA eligible, there is no effect to your contribution amount for the year. In the IRS’s eyes, you are covered by an HSA eligible plan for the full year, so you are able to make full contributions. The example here is you have an HSA eligible plan Jan > May, but in June you hop on an employer sponsored plan that is also HSA elibile. No problem, go ahead and make full contributions.

However, remember that the test for HSA eligibility occurs on the first of the month. This means that on the first day of each month, if you have HSA insurance and are an eligible individual, you “earn” 1/12th of the maximum contribution limit for that month. It follows that if you have coverage in each month, you earn 12/12 or 100% of the maximum contribution limit for the year. On the other hand, if you make a switch that is not in effect on the first of the month, you will lose that 1/12th of the contribution limit. The effect is your contribution limit is reduced and only equal to those months you have coverage.

The alternative scenario is covered by the final section…

3) Leave a HSA eligible plan mid year

Same scenario, covered by HSA eligible plan Jan > May, but you switch to a health insurance plan that is not HSA eligible in the middle of the year. What then?

This is where things get tricky. While the IRS is not super clear on this, the interpretation is that you are only allowed to contribute to an HSA for the months of a year you remain on the insurance plan. Basically, contribution limits are pro-rata based on the amount of time you are on the plan. If you are single ($3,300 2014 max) on the plan for 6 months, your maximum contribution limit is (6/12 * $3300) = $1,650. If you on the plan for 10 months, your maximum contribution = (10/12 * $3300) = $2,750. You are effectively capped out when you quit the plan to avoid taking advantage of the tax break.

That raises the real risk of penalties and taxes resulting from over-contributing. Consider the following scenario:

Strong earner
Maxes out HSA contribution early in year
Due to unforeseen circumstances, no longer HSA eligible sometime mid year

This presents a real problem for that person as they have in effect over contributed for the year. Even if they were able to reimburse their full contribution against qualified medical expenses, they have deducted too much from their income and will result with over contribution penalties and taxes, which are evil. The advice is you may want to space out your yearly HSA contributions by month / quarter as to avoid the risk of over contribution. This does not mean you cannot reimburse for prior medical expenses. In this scenario, you could incur $3,300 in qualified medical expenses in January and contribute monthly, reimbursing yourself for that $3,300 over time. However, this strategy puts a circuit breaker in the equation should you change health insurance to a non HSA eligible plan mid year, preventing you from penalties and taxes.

Note: to regardless of your coverage, to track your HSA spending please consider my service TrackHSA.com for your Health Savings Account record keeping. You can store purchases, upload receipts, and record reimbursements securely online.

HSA Last Month Rule and Testing Period – Explained

Update: I have finished and launched EasyForm8889.com, an online service to quickly and easily complete tax Form 8889 for your HSA. No matter your situation, it asks you simple questions and generates your completed Form 8889 PDF in less than 10 minutes. Try it today.

Two confusing concepts for Health Savings Accounts are the Last Month Rule and the Testing Period. Both of these help determine your contribution limit to your HSA during the year you first sign up for health insurance as an eligible individual. (Note: If you are filing HSA tax Form 8889 and are on Line 18 that says “Last Month Rule”, this only needs to be filled out if you failed the testing period and owe a penalty; read on. Otherwise, it is $0

I have created the following video to explain the Last Month Rule and Testing Period. Check it out, otherwise, the transcription of the information is below.

Watch on Youtube: HSA Last Month Rule and Testing Period

The Last Month Rule

The Last Month Rule states that if you are covered by an HSA eligible health plan on the first day of the last month of a given year, you are considered an eligible individual for the entire year. This gives you the option to contribute the entire year’s contribution limit to your HSA, which is more than you would be allowed otherwise (pro rata by month).

If you are covered by an HSA eligible health plan on 12/1 of a given year, you can contribute (and deduct) the full year’s contribution limit.

For example, you could begin HSA coverage in November of a given year. Come December 1st, you are covered and per the Last Month Rule, are considered an eligible employee for that full year. That allows you to contribute up to that year’s contribution limit, if you want, even waiting a few months to make a prior year contribution. Back up the truck and load up the HSA!

However, the Last Month Rule is a powerful tool that does bear risk and further responsibility.

The Testing Period

The Testing Period states that if you use the Last Month Rule, you must remain an eligible individual (covered by HDHP) for the next 12 months, so through December 1st of the following year. If you fail to remain an eligible individual (change insurance plans, lose insurance plan, receive other health coverage) during that time, any “excess” contributions you made as a result of using the Last Month Rule will be taxed and penalized.

If you contribute per the Last Month Rule and end your HDHP insurance before the Testing Period ends, excess contributions will be taxed and incur a 10% penalty.

In this case, “excess” contribution are amounts you contributed in violation of the Testing Period. Said another way, you contributed more based on the Last Month Rule, and the Testing Period required you to maintain HSA eligible insurance for one year. You did not fulfill this year, and you will have to subsequently recalculate what your contribution limit would have been and pay taxes / penalty on the difference. You can see this on the Form 8889 Instructions in Section 3, Line 18.

Calculating Last Month Rule Penalty

Using the Form 8889 Instructions, use the Line 3 Limitation Chart and Worksheet to calculate what your actual contribution limit was for the prior year, not using the Last Month Rule. For example, if you started HSA eligible insurance on August 1st, you would fill out (yearly) contribution limits for August, September, October, November, and December, then divide by 12. This number ($1396), your allowable contribution limit, will be compared to the contributions you made via the Last Month Rule.

Line 3 HSA Last Month Rule

Likely, you previously contributed more than you were allowed. The difference is your excess contribution resulting from failing the Testing Period, and this line will be entered on Line 18 of Form 8889. This excess contribution amount invokes a penalty for violating the last month rule in both 1) tax (your marginal tax rate, say 25%) + 2) penalty (10%). This flows through back to your taxes by 1) adding back this income to your taxable income and 2) assessing an additional penalty in Section 3 of Form 8889.

Testing Period Examples

Here are some examples to demonstrate how the Testing Period works:

Example 1 – no problem
Paul is covered by an HSA family insurance on December 1st. He is able to take advantage of the Last Month Rule and does, contributing the maximum to his HSA for that year even though he only had coverage for one month. He does not change plans for many years so passes the Testing Period, which lasted until 12/1 of the following year.

Contribution made = $6,650
Allowable contribution = $6,650 (fulfilled Testing Period)
Excess Contribution = $0

Example 2 – coverage type problem
George was covered by single HSA coverage from January – November, but on December 1st changed to family plan HSA coverage. Using the Last Month Rule, he contributed the full family amount for the year ($6,650) to his HSA. However, he ended his HSA eligible insurance in November of the following year, meaning he failed the Testing Period at its end on the following December 1st.

Contribution made = $6,650
Allowable contribution = $3,625 (11 months single; 1 month family)
Excess Contribution = $3,025
Taxes due = $756 ($3,025 x 0.25 tax rate)
Penalty = $303 ($3,025 x 0.1 penalty rate)

Example 3 – ending coverage problem
John is covered by a single HSA eligible insurance plan on December 1st. He is able to take advantage of the Last Month Rule and does, contributing the maximum to his HSA for that year even though he only had coverage for one month. He continues making monthly average contributions (contribution limit / 12) for 6 months until June 30th, when he switches jobs and no longer has HSA insurance. As a result, he is no longer an eligible individual during his Testing Period. He has made 18 monthly average contributions during 7 eligible months, so he now needs to declare 11 of those as income during the year and pay a 10% tax on that amount. His calculations are:

Contribution made = $3,350
Allowable contribution = $279 ($3,350 * 1/12)
Excess Contribution = $3,071
Taxes due = $768 ($3,071 x 0.25 tax rate)
Penalty = $307 ($3,071 x 0.1 penalty rate)

Effects of the Last Month Rule / Testing Period

In the above examples, the account holders were taking a calculated risk that they could satisfy the Testing Period of the following year. You can see the tax/penalty is substantial for failing it. Thus, while powerful, the Last Month Rule can be a double edged sword. Some effects are:

+ Can make full year contributions during years of partial coverage
+ Jump start contributions to your HSA
+ Can reduce your taxes in the year you sign up for an HSA
– Risk over contributing and invoking taxation + 10% penalty

Determine your risk

When making a decision about a Last Month Rule situation, consider the following which may negatively affect you during the Testing Period :

How likely are you to change jobs during the Testing Period? Will your future employer offer HSA plans
How likely are you to change plans during the year, do to changes in status or partner’s plan?
How likely is your employer to change your health insurance options during the Testing Period?

Perhaps the safest strategy is waiting until the following year (but prior to April 15th) to make a Prior Year Contribution. This ensures you do not over contribute during a period and have to declare and pay tax on an amount. The strategy here is to save monthly amounts in a non-HSA account, and after the fiscal year (but before April 15th), contribute the money to your HSA as a prior year contribution.

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Note: if you are having trouble with the Last Month Rule, please consider using my service EasyForm8889.com to complete Form 8889. It is fast and painless, and asks simple questions no matter how complicated your HSA situation.

Making Prior Year Contributions to your HSA

Jan 2015 update: I am finishing work on TrackHSA, a free service to help manage your Health Savings Account. Track purchases, upload receipts, and record reimbursements for all HSA purchases to help you minimize your taxes and satisfy the IRS. Sign up today.

One nice feature of your Health Savings Account is that you have some leeway as to when you are allowed to make contributions for a given year. We know that there is a contribution limit established each year ($3,300 / $6,550), but you don’t necessarily have to contribute any of it during that fiscal year.

That is because you can make prior year contributions to your Health Savings Account up until the tax filing deadline, which is usually April 15th of each year. A prior year contribution is simply a contribution that applies to the prior year’s contribution limit.

So for example, I could open an HSA in 2013 and not contribute a dime the entire year. On April 15th, 2014 I could contribute the maximum amount of $3,300 towards my HSA and designate that it apply to my 2013 contribution limit.

Said another way, even though we are in year 2014, I am contributing to my HSA in 2013, up to the contribution limit. The key is that, whenever you make a HSA contribution between January 1st and April 15th of a given year, there is an option on your HSA providers form to apply it to the previous year. Make sure to select the previous year if that is when you wish to apply the contribution.

Benefits of Prior Year Contributions

Catch up – The ability to make prior year contributions gives you the opportunity to catch up and fill your HSA if you are under your contribution for a given year. That way, you don’t miss any possible contributions and you can grow your HSA as much as possible.
Flexibility – While in theory funding and investing your HSA as early in the year is preferable (more time to grow), making a prior year contribution provides additional flexibility in that you have 3.5 extra months to find and contribute that cash.
Tax Planning – Any income you contribute to an HSA is tax deductible, meaning you don’t need to pay taxes on it. Thus, if you estimate your tax bill and find you have a tax burden, you can shelter some of that money from taxes by contributing to your HSA.

Likely, this rule was implemented because it makes no difference to the IRS what year your contribution goes towards as long as it is made prior to filing taxes. You can use this “loophole” to your benefit in the aforementioned ways.