Have you ever wondered what happens if you have a health savings account that you’re
contributing to and then…life happens…and you find yourself having to switch away from
your HSA’s required high deductible health plan to another health plan that isn’t HSA
eligible? And if that does happen, do you know that you could be stuck with some significant
penalties? In today’s video, I’ll go over the things you need to be aware of so you
know How to Avoid Health Savings Account Tax Penalties When Changing Your Health Plan.
Welcome to Healthy, Wealthy, and Wise...I’m Kevin and today we’re back talking about
health savings accounts, which I’m big fan of…when people know how to use them in the
best ways. In the past, I’ve shared videos with you on the benefits of having HSAs, and
how to maximize those benefits, particularly on how it can build wealth. I've talked about
the criteria to participate in one, the contribution limits, and I’ve even shared with you what
you should look for in selecting an HSA. In fact, I’ve shared with you why and what
HSA company I personally switched to in order to get the best performance possible. Now,
I’m not going to go over all of that information today, but if you’ve not seen those videos
and you’d like to get caught up, I’ll link videos with that information in the description
for you. Now for today’s video, I want to focus on what you need to know if you find
yourself needing to switch away from the health plan you have while contributing to an HSA.
And there’s really two major scenarios that are most likely to happen…one is you switch
your HSA-eligible health plan in the middle of the year, most likely because you switched
jobs or became eligible for Medicare…and then the second is that you are looking to
switch away from the high deductible health plan that your HSA requires at your annual
benefits enrollment. And then there’s also a less likely, but still common situation
where you may have just started an HSA sometime during the past year and then want to switch
away from an HSA-eligible plan less than 12 months after having started it, which can
be a big problem. We’ll go over everything you need to know so you don’t find yourself
not following the rules and then ending up with a big, unexpected tax bill… and I'll
give you some strategies to hopefully avoid those situations.
Upfront, this video is meant to be informative and should give you a lot of good information,
but it should not be taken as financial advice. Definitely consider consulting with a tax
professional or financial advisor to help you with your unique financial situation.
Alright, as we get into the scenarios, keep in mind, that no matter the situation, once
you leave an HSA-eligible, qualified high deductible health plan, you can still keep
your health savings account, but you just can’t contributing into it. So if on January
1st, you switch to a non-qualified plan or drop your insurance altogether, you can still
keep your health savings account and invest within it or pull out distributions for health
expenses, but you just can’t add any more money. If you do, not only is that money not
tax-deductible, you will also find yourself having to pay a 6% excise tax on that money…and
that’s not a one-time thing, you’ll pay that tax for every year that money remains
in your account. Needless to say, you want to avoid that.
So now let’s work through some of the most common scenarios I just mentioned. Let’s
start by saying you just got a new job and your new employer offers health insurance,
but they don’t have any qualified high deductible plans to choose from. As a heads up, if you’re
not sure if a plan is qualified, you can check out one of my videos on the current year to
see the criteria the plan needs to meet or you can always contact the insurance company
offering the plan directly and ask; that will give a definitive answer and peace of mind.
Now if they don’t have an HSA-eligible plan available, most likely you’re going to pick
a plan they have and then you’ll have to stop contributing to your HSA. Now if you’re
currently contributing to your HSA through payroll deductions from each paycheck, most
likely you won’t have any problems with excess contributions. However, if you contribute
to an HSA on your own, you might have contributed more than you were allowed for the part of
the year you were eligible. So for instance, let’s say you decided you want to contribute
up to the annual limit early in the year so that you could maximize the investment returns
of your contribution…afterall, it makes sense in that, in general, the more time the
money is invested in your account, the more money you’ll make. But of course you made
that contribution with the expectation that you would have an HSA-eligible plan for the
entire year. And now you find yourself having to switch to a non-eligible plan and you’re
putting yourself at risk for an excess contribution penalty. So what do you do? Well, the first
thing you need to figure out is how much money you were allowed to contribute for the part
of the year that you did have your HSA-eligible plan. And it’s actually pretty easy to come
up with that number. What you do is figure out how many months you had your eligible
plan. So let’s say you're starting your new job on September first; that means you
had a qualified plan from January through the end of August, which if you count them
is 8 months, right? So what you do is take your annual contribution limit, divide it
by 12 which is the total number months of the year and then multiply it by the months
you were covered, which in this case is 8. Now contribution limits vary from year to
year and can be higher if you’re age 55 or order, so you want to be aware of that…again,
you can reference one of my other videos for those numbers. But let’s say as an example
your contribution limit was currently 3600 dollars. So if you divide 3600 by 12, that
means for each month that you had an HSA-eligible plan, you could contribute up to $300. And
remember this includes any employer contributions if you had an employer that contributes towards
our HSA, so you want to make sure you count all the contributions together. Okay? Back
to our example, if you were starting a new job with a non-qualified plan on September
1st, that means for the first 8 months you were qualified to contribute to your HSA so
you would multiply that $300 times 8 which means you were eligible to contribute up to
$2400 for the current tax year. If you contributed more than that, that amount is what you would
have to pay the 6% excise tax on. Now if you did over-contribute, don’t worry, you can
fix that. According to the IRS, you may withdraw some or all of the excess contributions and
avoid paying the excise tax on the amount withdrawn if you meet the following conditions.
• First, you withdraw the excess contributions by the due date, including extensions, of
your tax return for the year the contributions were made.
• And second, you withdraw any income you earned on the withdrawn contributions…which
could be either interest or capital gains and include the earnings in "Other income"
on your tax return for the year you withdraw the contributions and earnings.
If you find yourself in this situation, definitely contact your health savings account provider
and have them work with you on this. Because this does happen to a lot of people, they’ll
have a process for you to follow. So the main thing I want you to know is that even if you
over-contributed, it can be corrected, you just got to get it fixed by the deadline for
the tax year, typically April 15th. Now we used the scenario where you were switching
jobs mid-year, but a similar situation is if you were transitioning to Medicare. Medicare
is not an HSA-eligible plan, so once you switch to Medicare, you can no longer contribute
to your health savings account. Again, you can still use it for health expense reimbursement
and invest the existing funds, you just have to stop contributing to it.
Now if you are someone that contributes to the plan on your own, remember that you can
contribute anytime from the first day of the first month you have a qualified high deductible
health plan up until the tax deadline, usually April 15th of the following year for the contributions
to be tax-deductible. If you’re concerned that your eligibility to contribute to an
HSA may change during the year and you don’t want to deal with the hassle of removing an
excess contribution, you have a couple of things you can do to prevent that from happening.
One thing you could do is only contribute the monthly allowance each month, knowing
for that month, you were qualified to contribute. To figure that out, again, that’s your total
annual contribution limit divided by 12. The other thing you could do is wait and then
contribute after January 1st up to the tax filing deadline of April 15th with the maximum
amount you can contribute. Just keep in mind that by delaying your contribution up to the
tax year’s filing deadline, that means less time your money is being invested so that
could have an effect your account’s performance, but for flexibility purposes and peace of
mind, that option might work best for you. Your choice!
Alright so let’s move on to the second big scenario. In this scenario, let’s say you’ve
had an HSA with a qualified high deductible plan, but decide that you want to change to
a non-HSA eligible plan for next year, maybe because you’re expecting some increased
healthcare needs and you want a lower deductible. Whatever the case, it just makes sense for
you so you want to switch your health plan. Now barring some life-changing event happening,
you’ll make that change during the annual benefits enrollment period with your new coverage
beginning on January 1st. But making that change might leave you unsure of what that
means for your HSA. The good news is that if you had your HSA and your HSA-eligible
plan for the entire year, you were able to contribute up to the annual limit for that
year for the full tax deduction. The only thing you will need to keep in mind is that
once your new non-qualified plan coverage starts on January 1st, you can no longer contribute
to your HSA. You can still keep the HSA, invest the current funds in it, take distributions
for healthcare-related expenses…you just can’t put more money into it going forward
when you don’t have that high-deductible plan.
Now, that’s probably the most common situation…but let’s say, you started your HSA with a new
high deductible plan mid-year and, for whatever reasons, want to change coverage for the following
year. This is where it gets tricky…and you have to be careful here. And it can happen
because of one of the rules of an HSA is that if you do start your account mid-year, literally
up to December 1st, you can contribute up the full year’s annual limit. Which is great,
right? You can get a tax deduction for the entire year even though you didn't have a
qualified plan for the entire year. The IRS calls this the last month rule, which you
might’ve heard of. But there’s a catch and you definitely want to keep this mind.
So what the IRS did was to make sure this rule wasn’t going to be abused, for instance,
someone could choose to not be insured all year and they pick up coverage in December
only to drop it in January and repeating that every year so that they could get the full
year tax deduction without being properly covered which is not the intent of the HSA.
And how the IRS did this was to implement what they call the testing period. So what
this is, is if contributions were made to your HSA based on you being an eligible individual
for the entire year under the last-month rule, you must remain an eligible individual during
the testing period. And the testing period begins with the last month of your tax year
and ends on the last day of the 12th month following that month…so for most of us,
December 1st of this year, through December 31st of next year.
Now if you fail to remain eligible during the testing period, for reasons other than
death or becoming disabled, you’ll have to include in income the total contributions
made to your HSA that wouldn’t have been made except for the last-month rule. You include
this amount in your income in the year in which you fail to be an eligible individual.
And then this amount is also subject to a 10% additional tax, so this is even more than
the 6% excess contribution excise tax we talked about earlier.
This might be a little confusing, so I’m going to try and clarify this in a more simple
manner. Basically if you have a qualified high-deductible plan for only part of the
year, but you contribute up to the annual limit in order to take the full tax deduction,
which you are allowed to do, you must then stay eligible by having an HSA-eligible plan
through December 31st of the next year. Because if you don’t, any contributions that you
wouldn’t have made except for the last month rule...so really the months before you started
your HSA-eligible coverage will then become income added towards your next tax bill and
that amount will then have an additional 10% penalty added to it. The way to figure out
that amount would be to use the worksheet from the IRS’s Form 8889, Part III. In the
description I have a link to the IRS’s guidance on health savings accounts and, within in
that, for the last month rule and testing period scenarios, there are a couple of examples
they use that might be helpful if you’re interested. But the main thing in general, the earlier
in the year you start the qualifying coverage, the less penalty you’ll be stuck with if
you don’t stay eligible throughout the entire testing period.
So if you find yourself in this situation, you want to weigh the benefits of getting
a full year’s tax deduction versus the potential penalty if you don’t. Again, sometimes life
happens and you can’t predict it. But there are some things that could do to reduce your
chances of getting stuck with the tax. The first thing is, if you used the last month
rule and took the full deduction, don’t switch to a non-eligible plan during the testing
period, unless you absolutely have to. The second thing is, if you feel unsure about
you being able to stay eligible throughout the testing period, because you foresee a
job change or will be transitioning to Medicare in the coming year, you might want to only
contribute for the months that you were eligible for, instead of taking the full year deduction.
And that amount can be figured the same way as we talked about in the first scenario at
the beginning of the video, where you take your annual contribution limit, divide it
by 12 and then multiply the result by the months you were actually eligible. So if you
have an annual contribution limit of $3600 and enrolled in an HSA-eligible plan on August
1st you would divide 3600 by 12 and multiple it by the months you were eligible, which
in this example would be five. And that would come to $1500. So if you only contributed
up to $1500, even though you could’ve contributed the full $3600 under the last month rule,
you would keep yourself from having to pay any potential penalties if for some reason
you weren’t able to stay eligible throughout the testing period.
I know when you start hearing numbers thrown around it can come across as a little confusing,
but I hope it makes a little more sense, even if you have to go back and listen to it a
second time. The key thing is just being aware that there are situations that could become
a problem, so at least you know you can reach out to your HSA provider or a financial advisor
for help. But hopefully this video helps you have a better idea of how to manage your HSA.
So if you did find it helpful, please like the video and if you want more information
on health savings accounts, definitely subscribe as I keep the community up to date on any
changes or updates with HSAs which happen every year.
Anyway, if you got this far, thanks for watching and I hope you have a great rest of your day.
Take care.