Tag Archives: Penalty

Last Month Rule Coverage Gap During Testing Period

This question was submitted by HSA Edge reader Paul. Feel free to send in your question today to evan@hsaedge.com.

What is the impact if I use the Last Month Rule and during the subsequent 12-month period I have a 1-month gap. Let’s say that I start my HSA on November 1st, then have Medicare in January, then have an HSA for the balance of the year. Do I have 10 months of excess contributions or one 1 because of January?

A condition of using the Last Month Rule is to abide by the Testing Period, which requires that you maintain HSA eligible coverage for the subsequent year. The Testing Period evaluates your status on the first day of each month; if you have HSA eligible coverage then you are considered covered by the HSA for that month.

If you had non HSA eligible coverage on the 1st of January you would fail the Testing Period. The result of this is any additional contribution from the prior year (above and beyond the 2 months you had coverage) is added back to income and taxed. Unfortunately, this occurs for the full (over) contribution amount, even if it was just 1 month missed in the Testing Period.

The penalty calculation is a bit tricky and if you need help, I recommend my site EasyForm8889.

Note: if you need help accounting for your HSA penalties from the Last Month Rule, please consider using my service EasyForm8889.com to complete Form 8889. It asks simple questions in a straightforward way and will generate your HSA tax forms in 10 minutes. It is fast and painless, no matter how complicated your HSA situation.

How to Avoid Health Savings Account Bank Fees

This question was submitted by HSA Edge reader Lillian. Feel free to send in your question today to evan@hsaedge.com.

I used to have an HSA account through my job but they are not offering that plan anymore, so now I have to pay a fee to keep that account open. Can I transfer that money to another account or another HSA bank where they would not charge me a fee even though my employer doesn’t offer that type of account?

Too many HSA fees

While Health Savings Accounts are a forward thinking way to save money and reduce medical expenses, the banks that provide the actual accounts have not fully caught up with the times. Their offerings suffer from poor web design, lack of tools and features, and restrictive / excessive fees. Even though HSA usage continues to increase at a rapid rate, traditional banks have not yet caught up, and avoiding fees for the HSA owner is an important part of protecting your investment. This article will review some commonly levied fees by one HSA custodian, and discuss 5 ways that you can reduce or eliminate HSA fees in your account.

Research fees structure before opening account

It is surprising how many fees there are related to HSA’s. Not just those specifically relating to your Health Savings Account, but other banking fees thrown in as well. For example, take a look at this screenshot from HSA Bank’s website describing some of their fees:

HSA bank fees

Granted, not all of these fees occur each month, and some of these are legitimate as they support costs for services. I do like how they list strategies on how to avoid the fee. However, as an HSA owner you need to look for recurring or transaction fees that affect your HSA. For example, here are some of the HSA related fees charged by that bank that directly affect HSA owners, some on every transaction!

ATM Withdrawal
Purchase using debit card
Manual withdrawal
Excess Contribution
Invest your HSA (monthly fee)
Account closing

While this bank is free to offer services they see fit, I hate being charged to access my money, so I see some of these fees as egregious and would shop around.

How to avoid HSA fees

Too many fees can add up and reduce your HSA balance over time. Plus, they are just annoying, since it is your money, and you are being nickel and dimed at every turn. As such here are some strategies to avoid or reduce Health Savings Account fees and charges.

Choose low fee plans – this involves doing a bit of research before you open your HSA. While the timing of opening your HSA is important, it is also important to get the best deal possible. Search around online and talk to your bank / credit union to see what types of plans they offer. Somewhere hidden on their website is the fee schedule that you need to review. Apply those fees to your situation and compare the plans of different providers. This will insure that you are at least aware of the fees charged and can choose what is best for you.
Switch HSA custodians – if you already have a Health Savings Account, you can still compare plans and switch to a new custodian if you find a better deal. This is easily done using an HSA Rollover to move funds between HSA accounts. Yes, you can have more than one HSA open at a time at different providers, and there is no tax or penalty to move HSA dollars between them. The point is you don’t have to stick with the HSA custodian your job set you up with, or the custodian where you first opened your account. Instead, do your fee research, find the best deal for you, and make a move if it makes sense.
Maintain the minimum balance – one of the best parts about HSA’s is you can invest your funds tax free. However, many banks have a minimum amount needed to invest, and others levy fees if you are investing but your investment amount is under a certain minimum. Thus, if you can beef up your HSA and meet those minimums investment amounts, the monthly fees will go away forever. This might involve making an extra contribution or two to your HSA, or waiting to invest it until you have the minimum available. I recommend keeping part of your HSA in cash (not invested) at all times in case you need it for health care. Once you have that amount set aside, you can begin investing the rest.
Choose cheapest options –if you look at the fee schedule above, you can see that they offer recommendations of how to avoid their HSA fees. Use this to your advantage by making choices that reduce fees charged. For example, there are a number of ways to pay for an HSA purchase. At the above bank, the associated fees are:
- ATM Withdrawal – $2
- Debit card purchase – $2
- Manual withdrawal – $10
- Online transfer – $0
Thus, it would make the most sense to purchase HSA elgible expenses on your credit card, and do an online transfer from HSA to bank to reimburse the purchase, making it tax deductible. Playing by the bank’s rules can add up and save you a lot of money over time.
Play by the rules –regardless of your bank fees, you want to be familiar with the rules of HSA’s. This will help you avoid taxes and penalties with the IRS as well as your HSA custodian. For example, excess contributions can usually be removed from your HSA before tax day without penalty. However, the HSA custodian above will charge you $25 for the pleasure. In addition, they charge $25 for a transaction correction, which consists of a change to the transaction type, amount, or tax year. By knowing what you can contribute and getting it done correctly the first time, you can avoid this $25 fee.

Note: if you need help reducing HSA bank fees, consider my service TrackHSA.com for your Health Savings Account record keeping. You can store purchases, upload receipts, and record reimbursements securely online. Besides tracking everything important, this will help you batch transactions for reimbursement and prevent mistakes that cost you money.

Using HSA Funds Once You Turn 65 Years Old

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Penalty on Non Qualified Withdrawals

Health Savings Accounts are generally required to be spent on qualified medical expenses. Contributions you make have great tax advantages based on the assumption that you will use them for their intended purpose, which is medical care for you and your family. Deviating from properly spending the funds can result in taxes due, as well as a 20% penalty. You can read about options for cashing out your HSA, but there aren’t many ways around getting money out without paying that 20% penalty.

That all changes once you reach the age of 65 years old. Besides being eligible for Medicare (which can affect your HSA eligibility), at age 65 your HSA no longer penalizes you for taking funds out of it. This is a huge advantage is your HSA becomes much more flexible and can be spent on anything, not just qualified medical expenses. This is one reason why HSA’s are a great retirement vehicle. While always avoiding tax on medical purchases, the HSA basically converts into a 401(k) or IRA (invest pre-tax, pay taxes later) at the time you turn 65. Conveniently, this is right around retirement time, so your HSA has served you like an IRA with a great medical option on it. As you will see, some distributions after age 65 will still incur a tax, but all distributions will avoid the 20% penalty. Per IRS Form 969:

Additional tax. There is an additional 20% tax on the part of your distributions not used for qualified medical expenses. However, there is no additional tax on distributions made after the date you are disabled, reach age 65, or die.

Using HSA funds for Qualified Medical Expenses at 65

Even after reaching 65, your Health Savings Account is still the best way to pay for medical, dental, or vision care for you and your family. This is because the triple-tax advantage still exists for the HSA: pre tax funds, no tax on earnings, and no tax for medical expenses. That means that any medical care you receive after age 65 is still paid for tax free using your HSA. You should remember this and guard those HSA dollars to avoid paying the tax man more than is needed.

For this reason alone, it may make sense not to use the HSA for things other than qualified medical expenses. As you will see, while you won’t be penalized on those “other” distributions, you will still be taxed, and in turn you forfeit the ability to spend those funds tax-free on medical care. Of course, even after age 65 you can still contribute to an HSA, but at that point you may not be on an HSA eligible plan or may have begun Medicare coverage, which prevents you from contributing. So once the genie is out of the bottle and the HSA funds are gone, it may be tough to get them back in and regain tax free medical spending. The point is to protect those HSA funds since they have the special ability to pay for medical care tax free, and we know that medical spending increases as we get older.

Using HSA funds for anything at 65

Above we mention the way to play this by the book, let’s talk about the fun way to use HSA funds. Once you turn 65, you can withdraw funds from your HSA without penalty. This means you can spend them on retirement, vacations, gifts for your family, fine wine and leather-bound books, or whatever you want. Any time before age 65 doing so would incur a steep 20% penalty on this “incorrect” usage of HSA funds, but in your golden years you can spend freely and enjoy the high life with your HSA. You no longer need to spend your HSA dollars only on qualified medical expenses.

After 65, HSA funds can be spent on things other than qualified medical expenses, but these amounts are added to income, which creates a tax liability.

The only downside is that you will still owe tax on these distributions from your HSA. Any funds you pull from your HSA for non qualified medical expenses will be added to income and taxed, but I argue this makes sense given the tax history of the contribution. You were able to contribute tax-free, your earnings grew tax free, and your funds need to be spent on medical expenses to continue to be tax free. Since you are not spending them on medical expenses, they are added to income like they should have been the year you made the contribution. However, at this point you have enjoyed the advantage of tax free investment growth compounded over many years.

In addition, delaying HSA distributions until this time is beneficial as your tax rate is likely lower in retirement. This results in less of a tax hit than it would have had you been taxed at the time of contribution, likely years ago. For example, at the peak of your career your marginal tax rate may have been 30%. But in retirement, you may be in a 15% tax bracket, so you have effectively arbitraged the tax system and saved yourself significant money.

Accounting for Distributions after 65 on Form 8889

Regardless of what you spend your HSA funds on, you will need to account for it each year with the IRS. This is done with HSA Form 8889 and specifically takes place in Part II – Distributions. We will examine two scenarios and how to account for them.

If you are 65 or older and use your HSA to purchase qualified medical expenses, your Form 8889 activity will look the same as if you were not 65. Specifically, you will call out the distribution, and classify it as being spent on qualified medical spending.

The following was prepared quickly using EasyForm8889.com

If you are 65 or older and you use you distribute from your HSA for something other than medical expenses, the treatment is a bit different. In this case, you call out the distribution amount but enter $0 for the amount spent on qualified medical expenses on Line 15. This will lead to taxable distribution on Line 16. However, there is a checkbox on 17a that you check for distributions over age 65, and line 17b backs these out from the 20% penalty.

This way, the amount is added back to taxable income but the penalty is avoided.

Note: if you need help accounting for your HSA distributions at age 65, please consider using my service EasyForm8889.com to complete Form 8889. It asks simple questions in a straightforward way and will generate your HSA tax forms in 10 minutes. It is fast and painless, no matter how complicated your HSA situation.