Tag Archives: Last Month Rule

Deciding to Use the Last Month Rule for New HSA Coverage

This question was submitted by HSAedge reader Beth. Feel free to submit your question today to evan@hsaedge.com.


I have an employer that is implementing an HSA eligible plan on 4/1/2017. Of course, everyone wants to invoke the “last month rule” but we keep telling them that is not a best practice due to the possible tax implications should they switch plans etc. Can you give some examples of “problems” with someone enrolling 4/1/2017 invoking the last month rule and not remaining covered during the testing period?

That is certainly a good question and applies to many people who begin HSA coverage mid year. As I see it, they have two options in front of them – reduce their contribution pro rata for the months covered, or contribute the full year amount by using the Last Month Rule. The former is safe with no risk of paying taxes and penalties in the following year, while the latter allows you to contribute more in the current year.

Contribute Only for Months Covered to Lower Risk

Let’s be clear on the situation facing your team. With coverage beginning on April 1st 2017, they will have 9 months of HSA eligible coverage for 2017. Stated differently, they are covered by a HSA eligible insurance for 75% (9/12) of 2017. Since they only have partial year coverage, the amount they can safely contribute to their HSA that year is reduced pro rata. In this case, they can contribute 75% of the contribution limit based on their coverage type and age, no strings attached. For 2017, these amounts are:

  • Self only: $3,400 x 0.75 = $2,550
  • Family: $6,750 x 0.75 = $5,062.50
  • if 55+: $1,000 x 0.75 = $750 in addition to above

So they can contribute those amounts, free and clear, and be finished. Making contributions for the months you had HSA eligible coverage means you never have to worry about taxes or penalties relating to the Last Month Rule.

Contribute More Using Last Month Rule

However, they may be aware that there is a provision called the Last Month Rule that states that if they have HSA eligible insurance on December 1st of a year, that they can contribute the full year contribution limit. Assuming they maintain HSA eligible coverage until December, this election allows them to contribute 100% of the $3,400 or $6,750, instead of just 75%. However, what they may not know is there is a catch. By taking advantage of the Last Month Rule, they are bound by the terms of the Testing Period. This basically states that they need to maintain HSA coverage for the following 12 months, or the amount they contributed above their calculated (75%) amount will be taxed and penalized.

People fail the Testing Period more often than you think, and it causes tax problems when they go to file Form 8889. It is difficult to predict over a year in advance what your insurance situation will be. Some events are not foreseeable. Other people don’t even know what the Testing Period is! For example, here are some common reasons people’s insurance changes and they fail the Testing Period:

  • Change jobs and get new insurance
  • Lose job and lose insurance
  • Change to a non HSA-eligible plan
  • Go onto spouse’s insurance
  • Change to state health insurance (Obamacare)
  • Go onto Medicare
  • Start taking Social Security

Any of the above will likely cause you to fail the Testing Period and owe taxes and penalties.

Calculating Taxes and Penalties for Failing the Last Month Rule

If you fail the Testing Period, you will have to go back and do a bunch of work for Form 8889. The IRS will have you compare the amount you contributed ($3,400 or $6,750) to the amount you could have contributed without the Last Month Rule ($2,550 or $5,062.50). The difference will be added to your taxable income for the current year and assessed a 10% penalty.

Here are the tax and penalty calculations for our previous examples. Assume you had 9 months of coverage and used the Last Month Rule to contribute the full 2017 contribution limit:

  • Self only: $3,400 – $2,550 = $850 added to income (taxed); $85 penalty
  • Family: $6,750 – $5,062.50 = $1,687.50 added to income (taxed), $168.75 penalty
  • if 55+: $1,000 – $750 = $250 added to income (taxed); $25 penalty in addition to above

As you can see, failing the Testing Period means writing Uncle Sam a check for taxes and penalties. For some people, this is a bad bet because they change insurance frequently, or the taxes / penalties / headache aren’t worth the additional risk. They contribute a little less this year but no big deal. For others, this is a good risk because they have stable insurance. It allows them to contribute more to their HSA and reduce current year taxes. There is no “right” answer and it is up to the individual HSA holder to decide.

Contributions when Changing to non-HSA Eligible Coverage

This was a reader question submitted by HSA Edge reader Kevin. If you have a question get in touch and we’ll try to help. Email us at evan@hsaedge.com any time.

My wife and I began a HSA-eligible policy August 1 of 2016. On January 1, we will switch to a non HSA-eligible plan… and will NOT be eligible to make HSA contributions in 2017 under this plan. If so, does that mean we are ALSO not able to make contributions in 2016 (without failing testing period and paying penalty)? This seems excessive. It would seem reasonable to allow a person to make a pro-rated (5 month) HSA contribution for 2016 in this case. But I cannot find confirmation anywhere that this is allowable.

If I understand you correctly, you have HSA eligible coverage from Aug through Dec of 2016. On January 1st 2017 you are switching to a new plan that is HSA eligible but ACA modifications make it de facto HSA ineligible.

If that is true, you can definitely still contribute to your HSA for 2016 but on a pro rata basis, i.e. proportionate for the months you had coverage. By my count that is 5/12 months so your contribution limits would be:

  • Single coverage = 5/12 * $3,350 = $1,395.83
  • Family coverage = 5/12 * $6,750 = $2,812.50
  • If you are 55 or older add 5/12 * $1,000 = $416.67 to above amounts

Using the Last Month Rule would allow you to contribute the full amount (e.g. $3,350 or $6,750) to the HSA, but as you point out, you would fail the Testing Period next year, resulting in penalties. The key point (that I will make clearer in that article) is the Last Month Rule is optional and if you don’t use it, you can just contribute for those months that you had coverage. Often this is the safest way to play it.

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Not Using the Last Month Rule when Coverage Changes


This question was submitted by HSAedge reader Kevin. Feel free to submit your question today to evan@hsaedge.com.


I have an additional question/scenario regarding the Last Month Rule I was hoping you could help with. My wife and I began a HSA-eligible policy August 1 of this year. On January 1, we will switch to an Obamacare plan that is not HSA eligible. I assume that we would NOT be eligible to make HSA contributions in 2017 under this plan. If so, does that mean we are ALSO not able to make contributions in 2016 (without failing testing period and paying penalty)?

If I understand you correctly, you have HSA eligible coverage from Aug through Dec of 2016. On January 1st 2017 you are switching to a new plan that is HSA eligible but ACA modifications make it de facto HSA ineligible.

If that is true, you can definitely still contribute to your HSA for 2016 but on a pro rata basis, i.e. proportionate for the months you had coverage. By my count that is 5/12 months so your 2016 contribution limits would be:

  • Single coverage = 5/12 * $3,350 = $1,395.83
  • Family coverage = 5/12 * $6,750 = $2,812.50
  • If you are 55 or older add 5/12 * $1,000 = $416.67 to above amounts

The key point is that you can always contribute to your HSA for times that you had HSA eligible coverage, full stop. You then have the decision of whether to use the Last Month Rule or not, so it is optional. Using it allows you to contribute the full year’s HSA contribution limit (e.g. $3,350 or $6,750 above) regardless of actual time covered. Not using it -and this is what trips people up- reverts to the default, which is a contribution limit determined by the number of months coverage. No one is forced into using the Last Month Rule, and doing so can be detrimental, since as you note the Testing Period comes into play along with the risk of penalty.

So in your situation, with an upcoming coverage change that would fail the Testing Period, it is definitely best to avoid using the Last Month Rule.