When Two or More Accounts within a Family Makes Sense

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“By establishing the account now, the child can reimburse tax-free any eligible expenses that she incurs for the rest of her life if she keeps a positive balance in the account. Let that sink in. . . Parents who realize this opportunity understand the value of setting up an account for their child. It could be worth thousands of dollars to the child in the future.”

William G. (Bill) Stuart

Director of Strategy and Compliance

May 13, 2021

In most cases, it’s appropriate to own and fund a single Health Savings Account to reimburse tax-free all family member’s eligible expenses. That’s a good thing since it minimizes the cost (measured in fees and time) to manage this aspect of financial life. But in some situations, it makes sense for additional family members to establish a Health Savings Account. Let’s look at some of the scenarios in which a second – or third or fourth – account for a family member covered on a family medical plan may reap additional financial benefits.

Catch-up Contributions

The most obvious case for a second Health Savings Account is a spousal account once the spouse turns age 55 and is eligible to make a $1,000 annual catch-up contribution. Catch-up contributions must be made to an account owned by the person eligible to make the deposit. Anyone can provide the funding, though it’s usually the couple.

The spouse typically can’t make the contribution through a pre-tax payroll deduction (unless her employer has Cafeteria Plan rules that allow employees with other medical coverage to fund a Health Savings Account in a program outside that company’s benefit plan). But she – or anyone else – can fund the account with after-tax dollars and she can deduct the contribution on her (or the couple’s joint) personal tax return.

The deduction reduces their federal and state (except in California and New Jersey) income taxes dollar-for-dollar, although they don’t receive a credit for payroll taxes paid on the money when they earned it. That’s a lost tax-savings opportunity of up to $76.50, though the corresponding benefit is that the account owner’s income reported to the Social Security Administration isn’t reduced by the amount of the contribution, as it is when deposits are made through an employer’s Cafeteria Plan.

Worker No Longer HSA-eligible

Here’s an increasingly common scenario: A working senior is enrolled in HSA-qualified coverage because it’s the only plan that the company offers. But the employee isn’t eligible to fund a Health Savings Account because they’re enrolled in Medicare. Perhaps they’re collecting Social Security benefits, which results in automatic Medicare Part A enrollment if they’re age 65 or older. Or their company has 19 or fewer employees, and the company’s insurer requires all Medicare-eligible workers to enroll in Medicare as a condition of remaining on the employer-sponsored plan.

If their spouse is HSA-eligible (regardless of their age), they can open and fund their own Health Savings Account. And they can fund it to the statutory maximum ($7,200 in 2021), plus the additional $1,000 annual catch-up contribution if they’re age 55 or older. That’s right, they can fund their account to the family limit, even though they’re the only family member who’s HSA-eligible. The amount of the contribution is based on the number of people covered without regard for who’s eligible to fund a Health Savings Account.

They typically can’t make pre-tax payroll deductions. But all deposits are tax-deductible, so the couple reaps the tax savings when they file their joint personal income tax return. They don’t receive a credit for payroll taxes paid, which may run as high as $627.50 on a $7,200 contribution.

Spouse Is Older

There’s a caveat in Health Savings Account rules that’s important for certain couples to know. Distributions to pay for Medicare premiums are an eligible expense and therefore tax-free – but only if the account owner is age 65 or older.

Imagine a 65-year-old wife and her 57-year-old husband. The husband carries the insurance. He contributes the family maximum every year through pre-tax payroll deductions. The wife made $1,000 catch-up contributions for 10 years, then enrolled in Medicare at age 65 when she started collecting Social Security benefits.

Her premiums for Medicare Part B ($144.50 or more monthly in 2021) and Part D (an average of about $40 per month) are about $2,200 per year. Let’s say she earned $2,000 in interest on her $10,000 of Health Savings Account catch-up contributions from age 55 to 64. That $12,000 balance will fund about six years of premiums. The family will then have to pay an additional two years’ premiums with after-tax dollars until her husband turns age 65 and can withdraw funds from his account to pay her Medicare premiums tax-free.

A better approach: Before she turns age 65, the couple can allocate a portion of the maximum family contribution to her Health Savings Account. For example, if they split the maximum contribution equally between their two accounts in 2020 and 2021, deposits in her account would have increased by a two-year total of $7,150 – more than enough to cover all her Medicare premiums until her husband turns age 65 and can withdraw funds tax-free from his Health Savings Account to pay her Medicare premiums. Yes, they may have missed out on up to $547 of payroll tax savings during those two years if they’d contributed the family maximum through his company’s Cafeteria Plan. But if their marginal federal and state income tax rates are 27%, they’ll save more than $1,200 in taxes by paying her Medicare premiums from her Health Savings Account until he turns age 65.

Note: He can reimburse his wife’s Medicare deductibles, coinsurance, and copays, plus her eligible dental, vision, hearing, and over-the-counter expenses, tax-free from his Health Savings Account, regardless of his age. The restriction above applies only to her Medicare premiums.

Domestic Partners and Ex-spouses

A Health Savings Account owner can’t reimburse their domestic partner’s or ex-spouse’s eligible expenses tax-free – even if their domestic partner or ex-spouse is covered on their medical plan. That holds true even if they must pay a portion of their ex-spouse’s out-of-pocket medical costs by court order. A judge can require them to pay, but they can’t overwrite federal tax law to allow those payments to flow through a Health Savings Account tax-free.

In these cases, both adults covered on the same medical plan can fund their own Health Savings Account if they meet all eligibility requirements. Federal tax law is clear in stating that spouses can split the statutory maximum annual family contribution between their two accounts as they wish, but the statute is silent on how much each adult can contribute when not married. The industry rule of thumb, based on informal comments made by an IRS employee at an industry conference in 2010, is that each unmarried adult can contribute up to the family maximum. (But you may want to consult your tax professional to determine your contribution strategy if you’re in this situation, as this approach isn’t codified in federal tax law.)

That’s good news since an account owner can’t reimburse tax-free any expenses – even eligible expenses – that a domestic partner or ex-spouse incurs. This additional account allows the domestic partner or ex-spouse to reimburse tax-free her own and her tax dependents’ eligible expenses tax-free.

By the way, anyone – including the medical-plan subscriber – can fund the domestic partner’s or ex-spouse’s account. The account owner receives the tax benefit, regardless of who contributes.

And one more point: A domestic partner’s or ex-spouse’s participation in a general Health FSA does not disqualify you from funding your Health Savings Account (although it disqualifies them from funding theirs).

Adult Children

Health Savings Account owners can reimburse tax-free all eligible expenses that they, their spouse, and their tax dependents incur, regardless of the family members’ coverage. What about an adult child who’s no longer a tax dependent? An account owner can’t reimburse that child’s eligible expenses tax-free, even if they’re covered on the family medical plan.

What’s a parent to do? Well, one option is to open a Health Savings Account in the child’s name. The parent or anyone else can fund the account, although the child receives the tax deduction. (I’d recommend that a parent who is inclined to seed the account consider challenging the child to save by matching the child’s contributions.) The child can reimburse their own eligible expenses tax-free and add contributions as they wish, up to the statutory maximum for a family contract. (Again, this contribution ceiling isn’t codified in federal tax law.)

By establishing the account now, the child can reimburse tax-free any eligible expenses that they incur for the rest of their life if they keep a positive balance in the account. Let that sink in. They can move to traditional coverage for decades, then become HSA-eligible again in their mid-50s. At that point,  they can fund their Health Savings Account and reimburse themselves for all eligible expenses that they incurred since the date that the account was initially funded years earlier. Parents who realize this opportunity understand the value of setting up an account for their child. It could be worth thousands of dollars to the child in the future.

Segregating Funds

It’s generally not necessary for one person to own more than one Health Savings Account. The contribution limit doesn’t increase, nor does the range of people whose eligible expenses can be reimbursed tax-free grow when someone owns multiple accounts.

There’s a situation in which one person might want to own more than one account. Imagine you understand Health Savings Accounts thoroughly and appreciate the fact that you can save for eligible expenses in retirement in an account that’s not subject to any tax friction. You realize that this tax treatment is superior to a tax-deferred or Roth-qualified retirement plan. As a result of this knowledge, you want to deposit a portion of your annual retirement savings into your Health Savings Account to build that balance to pay eligible expenses tax-free in retirement.

But you don’t trust yourself completely. You’re concerned that if you incur a sudden, high expense, you may be tempted to spend the funds that you planned to save for retirement. You’re afraid that, like a desperate farmer, you’ll “eat the seed” and may face starvation with a smaller crop the following year.

One strategy to avoid this problem is to open a second Health Savings Account. You’ll continue to receive employer contributions and payroll deductions into the account administered by your employer’s account partner. But you’ll periodically make trustee-to-transfers to move balances from that account to your second Health Savings Account. To make sure you don’t send balances in the second Health Savings Account, you cut up the debit card.

If you’re disciplined financially, this two-account strategy may represent overkill. On the other hand, if you’re remotely concerned that you’ll be tempted to withdraw too much – or your employer’s partner offers an inadequate menu of investment options to meet your financial needs – it’s worth considering a second account. Look for one with no fees and a range of investment options that satisfies your needs. Other features – debit cards and access to money, ease of manual reimbursement – aren’t relevant.

The Bottom Line

One of the great features of Health Savings Accounts is their flexibility. Another is the fact that they’re individual accounts, not an employer-sponsored plan, so more family members than just the employee have an opportunity to participate. Those who gain most from these provisions in federal tax law are the people who understand these provisions and use them to their benefit. And now you join their ranks.

What We’re Reading

Can we provide a better coverage option than Medicaid for the poor? Scott Atlas ponders that question here.

How does the new COBRA subsidy affect your eligibility to fund a  Health Savings Account? I look at this question from multiple angles here.

Two senators recently re-introduced legislation allowing HSA-qualified plans to cover high-value care for chronic conditions below the deductible. This provision would make HSA-qualified plans a more attractive option to many of the 133 million Americans with one or more chronic conditions. Learn more here.

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