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How to manage multiple HSAs for couples

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Americans spent over $3.5 trillion on health care in 2018, with the U.S. claiming the highest total health spending per capita in a recent global survey. As such, one of the major planning concerns for many individuals is managing health-related expenses.

To help mitigate the burden of those high priced health care, some insurance policies allow certain covered individuals to make contributions to HSAs, which of course offer a triple-tax benefit — where contributions are tax-deductible, growth is tax-deferred and qualified withdrawals are available tax-free.

The caveat to the various tax-saving benefits available to the HSA owner is that, like all other tax-preferenced accounts, HSAs require compliance with a number of rules, including limits around how much an HSA owner can contribute to the account, when funds can be used and what counts as a qualified expense.

Compliance with these rules can become especially complex when married couples are collectively covered by more than one high-deductible health plan. Both spouses may want to take advantage of the benefits of HSAs, but must coordinate with each other in the process.

The reality is that most people will incur significant out-of-pocket costs for health care over their lifetimes. That’s especially true for those who are contributing to HSAs.

Of all the tax-favored accounts created by the Internal Revenue Code, the HSA arguably offers the best cumulative tax benefits, offering a unique trio not provided with other accounts. These benefits include: the opportunity for tax-deductible contributions; tax deferral of funds as they grow within the HSA shell; and, the potential for tax-free distributions when used for qualified medical expenses.

But while HSAs offer tax benefits in the form of tax-free growth when used for qualified medical expenses, using HSA funds for medical expenses immediately as they arise can be a less efficient way to benefit from the account.

Rather, for those who can afford to pay for current medical expenses with other income/savings, the better way to use an HSA account is to fund it, invest it and let it grow, uninterrupted by distributions for many years, and then use it for accumulated medical expenses down the road. By doing so, the HSA assets can compound, providing even more growth that can later be distributed and used tax-free.

For those individuals lucky enough to avoid material amounts of medical expenses over the years, the HSA offers attractive perks to be realized later in life. Specifically, while HSA distributions that are not attributable to qualified medical expenses are generally taxable and subject to an additional 20% penalty — thus, the benefit of using an HSA for medical expenses — IRC Section 223(f)(4)(C) eliminates the 20% nonqualified withdrawal penalty once an individual reaches age 65.

That means after age 65, an HSA that is not used for qualified medical expenses essentially becomes a slightly better version of a traditional IRA, eligible for the same tax-deferred-with-future-taxable-withdrawals treatment but with the distinction that while traditional IRAs are subject to required minimun distributions once an account owner reaches age 70 and a half, HSAs have no distribution requirements during an owner’s lifetime.

As such, in comparison to owners of traditional IRAs, HSA owners can exercise a greater level of control over when to distribute funds from their account — and a greater duration over which compounding occurs tax-deferred.

HSA UPON DEATH
In the event an HSA owner dies before depleting all the funds — an increased risk when the account is deliberately accumulated and grown, and not used for years or decades — the treatment of the remaining funds will vary depending on the beneficiary of the HSA.

More specifically, one set of rules is followed when the beneficiary is the decedent’s surviving spouse, and another is followed if the beneficiary is anyone else. Not surprisingly, surviving spouses receive more favorable treatment.

Per IRC Section 223(f)(8)(A), if an HSA owner’s spouse is the designated beneficiary, then upon the HSA owner’s death the account becomes the surviving spouse’s own HSA account as of the date of death. In practice, however, most custodians will require that the surviving spouse establish their own HSA tied to their own Social Security number prior to taking any distributions.

By contrast, when an HSA owner’s beneficiary is any person other than the owner’s spouse, the account ceases to be treated as an HSA as of the date of the owner’s death. Any remaining funds in the account are treated as distributed to the beneficiary — that is, not the original owner, but the subsequent beneficiary — on the date of death, and thus are taxable to the beneficiary in the year of the death. An exception is specified in IRC 223(f)(8)(B)(ii)(I), whereby the funds are used to pay the decedent’s medical expenses within one year of the date of death.

In the event that an HSA owner’s beneficiary is their estate, IRC 223(f)(8)(B)(i)(II) requires that the remaining value of the HSA be included in the decedent’s income in the year of death.

HSAs OR HDHPs
Notwithstanding the less favorable income tax consequences for an HSA that ends up never being used and left to a non-spouse beneficiary upon death of the owner, the unique triple-tax benefits of an HSA make the account one that nearly every taxpayer would benefit from.

Not all taxpayers, however, are eligible to contribute to such accounts.

To contribute to an HSA, an individual must be covered by a qualifying High Deductible Health Plan, or HDHP. Such plans incorporate both a minimum annual deductible amount as well as an annual out-out-pocket maximum that limits just how high that high deductible can be — both of which are set by the IRS. Since not all HDHPs meet these requirements, individuals who want to establish an HSA should be careful to choose the right HDHP, or at the very least inquire about whether their HDHP option meets those requirements.

For instance, some plan deductibles are high enough that they exceed the out-of-pocket maximum. These HDHPs would not qualify an individual to contribute to an HSA.

For 2019 and 2020, the minimum annual deductibles and maximum out-of-pocket expenses for self-only and family — defined as an HDHP that provides coverage for the policyholder and at least one other person — coverage are as follows:

Furthermore, HSA-eligible HDHPs are prohibited from offering “first-dollar coverage,” that is, immediate coverage of co-pays or co-insurance amounts. Participants themselves are required to pay out-of-pocket for their initial medical expenses.

In addition to being covered by an HSA-eligible HDHP, in order to qualify to make an HSA contribution an individual must also:

  • Not be enrolled in any other non-HSA-eligible high-deductible health plan, with limited exceptions, including Medicare and Tricare;
  • Not be claimed as a dependent on someone else’s return;
  • Not be enrolled in a Health care Flexible Spending Account, or FSA, other than a limited-purpose FSA or a post-deductible FSA; and
  • Not be enrolled in a Health Reimbursement Account, or HRA, other than a Limited-Purpose

HSA, Suspended HRA, Post-Deductible HRA, Retirement HRA or certain Qualified Small Employer HRAs.
Notably, while many individuals don’t opt for coverage in HSA-eligible HDHPs, such plans have gained significant traction in recent years. Studies from the Centers for Disease Control and Prevention show dramatic increases in the number of working-age individuals with HDHP coverage. Between 2007 and 2017, the percentage of working-age adults with employment-based health insurance and enrolled in HDHPs increased from 14.8% to 43.4%.

Like other tax-favored retirement accounts, HSAs are subject to annual contribution limits. For persons with HSA-eligible, self-only HDHP coverage for all of 2019, the maximum HSA contribution is $3,500 — $3,550 for 2020 — while the maximum combined HSA contribution for 2019 for individuals covered by HSA-eligible family HDHP coverage for the entire year is $7,000 and $7,100 for 2020.

Note that for persons not covered for the full year under an HSA-eligible HDHP, or for those who switch from self-only coverage to family coverage mid-year, the annual contribution limit may be lower. In some situations, however, the so-called last-month rule may still allow a full year’s contribution to be made, provided the same coverage is maintained throughout a testing period. For more information see IRS Publication 969, “Health Savings Accounts and Other Tax-Favored Health Plans.”

It’s also worth noting that like IRAs, HSAs are individual accounts. To that end, there is no such thing as a joint HSA. When one spouse is covered by an eligible HDHP but the other is not, an HSA contribution can only be made to an account owned by the spouse who is covered by the eligible HDHP.

On the other hand, when both spouses are covered under one HSA-eligible family HDHP, each spouse can open and fund their own HSA account. In other words, HSA accounts themselves are specific to the individual, but a high-deductible health insurance plan that is HSA-eligible can render multiple individuals covered under the plan as HSA-eligible.

Similar to the rules for other tax-preferenced accounts, the contribution limits for HSAs are increased for certain older HSA-eligible HDHP participants.

More specifically, eligible individuals who are 55 or older by the end of the year are eligible to contribute an additional $1,000 to their HSA account. In the event both spouses of a married couple are eligible to make an HSA contribution, and both are 55 or older by the end of the year, each spouse can make up to an additional $1,000 contribution to their own HSA.

COORDINATING HSA CONTRIBUTIONS
In many situations it is common for spouses to each be covered under separate health insurance policies, especially if both spouses are working. That’s because most employers tend to pay for a higher percentage of the cost of health insurance when just the employee is covered, as opposed to when the employee elects to extend their employer-provided health insurance to additional family members.

According to the Kaiser Family Foundation, employees with individual health coverage in 2019 pay on average 18% of the cost of their policy. Conversely, employees with family coverage in 2019 are on the hook for 30% of the cost of coverage. Thus, when both spouses are working and have the option to participate in employer-provided health coverage, it is often more cost-effective for each to be covered separately under their own employer’s plan as an individual than to get one family plan.

Combined with the rise in the adoption of HSA-eligible HDHPs as a means of health insurance coverage, this makes it increasingly likely that spouses will each be covered by a separate HSA-eligible HDHP, as it would generally cost them less for such coverage than to have a single policy via one employer covering both individuals.

In such situations, advisors can coordinate HSA contributions between spouses to ensure contributions to their HSAs don’t exceed the applicable contribution limits. Indeed, under IRC Section 4973(a)(5) any such overages are subject to a 6% excess contribution penalty for each year they remain in the account.

Perhaps the most straightforward scenario is when each spouse has health insurance coverage via a separate HSA-eligible, self-only HDHP. In such situations, each spouse may contribute to their own HSA up to the maximum for self-only HDHP coverage — $3,500 for 2019, with an additional $1,000 permitted for individuals age 55 and older.

Example No. 1a: Fred and Wilma, both 31, are married and have self-only health coverage through their employer’s HSA-eligible HDHP.

Fred and Wilma understand the unique tax benefits offered by an HSA, and therefore they’ve decided to sock away as much as possible into their accounts. To maximize their contributions for 2019, Fred and Wilma must each contribute $3,500 into their own HSA.

If one spouse does not contribute the maximum amount though, the other spouse cannot exceed the maximum contribution limit applicable to those with self-only HSA-eligible HDHP coverage to make up for the other spouse’s shortfall.

Example No. 1b: Barney and Betty, both 56, are married and have self-only health coverage through their employer’s HSA-eligible HDHP.

Betty is concerned about future health care costs and wants to maximize contributions to their respective HSAs. Barney, on the other hand, doesn’t really worry too much about future medical costs, and would rather spend money on bowling.

So Barney contributes only $1,500 to his HSA for 2019 instead of the $3,500 + $1,000 = $4,500 maximum amount he can contribute.

Betty can contribute the maximum of $3,500 + $1,000 = $4,500 to her HSA for 2019, but is unable to contribute any additional amount to make up for what Barney could have contributed to his HSA.

OTHER CONTRIBUTION CONSIDERATIONS
Another possible scenario that advisors may encounter is one spouse having self-only coverage while the other spouse has family coverage. This situation is most likely to arise when a married couple has children, each spouse has employer-sponsored and subsidized health insurance coverage, and the couple decides to put all the children under one spouse’s plan as a family while keeping the other spouse separate.

In such cases it may be possible for one spouse to have self-only coverage, while the other spouse covers only themselves and the children via employee and children coverage. Where offered, the latter coverage is less expensive than a family plan, but because this policy covers the policyholder and “at least one other person,” it is still considered family coverage for the purposes of determining the applicable HSA contribution limit.

Thus, in a situation where one spouse has the ability to purchase employee and children coverage, and the other spouse has access to a highly subsidized self-only coverage option through their employer, total premium costs may be less expensive than if a single policy were purchased through either spouse’s employer covering the whole family.

Note that while premium outlay may be less when coordinating coverage as described above, couples should carefully evaluate other potential costs. For example, regardless of when the maximum out-of-pocket deductible is met on the employee and children policy — which can be as high as $13,500 in 2019 — the spouse with self-only coverage is responsible for their own medical expenses and must meet the deductible and out-of-pocket limits tied to their own policy.

When one spouse has coverage via an HSA-eligible employee-and-children family HDHP for HSA contribution purposes and the other spouse has a self-only HSA-eligible HDHP, the maximum combined amount that can be contributed to the couple’s HSA accounts for the year is the maximum family amount — $7,000 in 2019 — plus any allowable catch-up contributions.

In other words, the maximum combined amount that can be contributed to both spouses’ HSAs is the exact same amount that would apply if both spouses were covered under one HSA-eligible family HDHP. The fact that there’s an extra plan, and even the possibility that one spouse is covered under two plans, doesn’t change the family limitation in the aggregate — which is still just two times the individual limit.

But while the maximum combined amount that can be contributed to the couple’s HSA accounts is the same, the fact that the spouses have different types of coverage does introduce a wrinkle. More specifically, the spouse with self-only coverage can contribute only up to the maximum allowable amount based on self-only coverage to their HSA — $3,500 in 2019 — plus any allowable catch-up contribution. Meanwhile, the spouse with the family plan can contribute all the way up to the 2019 family limit of $7,000.

Example No. 2a: Charlie and Lucy are married and are each 31 years old. Lucy has employee and children family coverage through her employer’s HSA-eligible HDHP, while Charlie has self-only coverage through his separate employer’s HSA-eligible HDHP.

Lucy is concerned about their future health care costs and wants to maximize contributions to their HSAs. Charlie, on the other hand, contributes nothing to his own HSA.

Despite Charlie’s potential shortsightedness, Lucy can still ensure that they make the maximum combined contribution for 2019 by contributing $7,000 to her own HSA because she has an HSA-eligible family HDHP.

Conversely, if the spouse with self-only coverage is 55 or under at the end of the year — i.e., not yet eligible for a catch-up contribution — then any amounts contributed to their own HSA will reduce the maximum amount that can be contributed to the HSA of the spouse with family coverage, dollar for dollar.

But if the spouse with self-only coverage is 55 or older by the end of the year, then any amounts contributed to their own HSA — above and beyond the $1,000 catch-up contribution amount — will reduce the maximum amount that can be contributed to the HSA of the spouse with family coverage, dollar for dollar.

Put differently, contributions to the HSA of the spouse age 55 or older with self-only coverage first go toward meeting any allowable catch-up contribution limit and then begin to offset the amount that can be contributed to the HSA of the spouse with family coverage.

Example 2b: Fred and Daphne are married and are each 56 years old. Fred has employee and children family coverage through his employer’s HSA-eligible HDHP, while Daphne has self-only coverage through her separate employer’s HSA-eligible HDHP.

Fred wants to maximize contributions to their HSAs, but Daphne is less concerned about contributions and only saves $1,500 to her own HSA account.

The first $1,000 contributed to Daphne’s self-only account will go toward satisfying her catch-up contribution amount. The remaining $500 will reduce the amount that Fred can contribute to his HSA, dollar for dollar. Thus, if Fred wants to maximize the couple’s combined HSA contributions for 2019, he must contribute $7,000 - $500 = $6,500, plus his $1,000 catch-up contribution amount for a total of $7,500, to his own HSA.

The final scenario to consider is when both spouses each have a family HSA-eligible HDHP that covers the other. This is admittedly less common, as it’s likely that the couple would opt for coverage under only one family HSA-eligible HDHP to reduce the premium costs and avoid paying for two plans, unless both family plans are fully subsidized by the employer.

Nevertheless, in situations where both spouses’ employers generously cover the full cost of an HSA-eligible family HDHP, or where the added premium cost of two such policies is worth it for some reason — e.g., different in-network of doctors available in each plan — couples may find themselves in the unusual position where each spouse is covered by separate HSA-eligible family HDHPs.

Not surprisingly, being covered by two HSA-eligible family HDHPs does not increase the maximum allowable annual contribution beyond the regular maximum amount for family coverage. In fact, the contribution limits for such situations are exactly the same as they are when both spouses are covered under just one HSA-eligible family HDHP.

When both spouses are covered by separate HSA-eligible family HDHPs, the default is for the maximum family contribution limit to be split evenly between the two spouses. However, the couple can decide to divide the family maximum contribution limit however they see fit.

Note that presuming the spouses’ combined contributions do not exceed the family maximum contribution amount, it’s presumed that their respective contribution amounts were determined in agreement; there is no special form or election that must be made.

Of course, since a catch-up contribution for an individual can only be made to their own HSA — regardless of family contribution limit flexibility — in situations where both spouses are 55 or older one spouse will have to contribute at least $1,000 to their own HSA for the couple to maximize their cumulative HSA contributions for the year.

Example No. 3: Hank and Peggy are married and are each 56 years old. Both of their employers cover the full cost of an HSA-eligible family HDHP and thus, Hank and Peggy are each covered by both policies.

The partners want to maximize contributions to their HSAs for 2019. Given they’re both old enough to make catch-up contributions, they are able to contribute as much as $7,000 (family limit) + $1,000 (Hank’s catchup) + $1,000 (Peggy’s catchup) = $9,000 to their HSAs for 2019.

However, Hank and Peggy each need to make catch-up contributions to their respective HSA accounts. Once they do, the remaining $7,000 of regular contributions can be split between their accounts however they see fit.

VALUE MAXIMIZATION STRATEGIES
As noted above, when both spouses have coverage via an HSA-eligible HDHP, there is often flexibility as to how the maximum HSA contribution can be allocated between the two spouses’ HSA accounts. It still matters, however, when or where those contributions are made for maximum efficiency.

When two spouses are different ages and at least one is under age 65, contributions should be skewed to the extent possible to the older spouse’s HSA. Recall that HSA distributions used to pay or reimburse the HSA owner for qualified medical expenses are tax- and penalty-free, regardless of whether the HSA owner has reached age 65.

By contrast, when HSA distributions are made without reimbursable qualified health expenses, the treatment is markedly different for those who have reached age 65 compared with those who have not yet reached it.

More specifically, while such non-medical distributions before and after age 65 are subject to ordinary income tax, only distributions made before age 65 are subject to the additional 20% penalty. Consequently, by prioritizing contributions to the older spouse’s HSA, more of the funds will be available should the need to distribute funds for nonqualified expenses arise, thereby increasing the likelihood of avoiding the 20% penalty.

In the event the younger spouse has already reached age 65, the preference to concentrate contributions in the older spouse’s HSA can be discarded if contributions are still being made to the HSA — a scenario that would generally require the spouses to be covered by a large employer’s group plan, or else Medicare would become the couple’s primary insurer and HSA contributions would no longer be allowed — as the tax treatment for all distributions would now apply equally to both spouses.

Finally, while an older spouse is typically more likely to predecease a younger spouse, that fact does not change the HSA contribution strategy. Recall that when a spouse is named as an HSA owner’s beneficiary, the HSA remains an HSA, and is deemed to belong to the surviving spouse upon the owner’s death.

As long as spouses name each other as designated beneficiaries on their accounts — something advisors should always double-check — the surviving spouse will have access to the HSA funds in the same manner as if they had been contributed to their HSA directly in the first place.

PRIORITIZATION CONSIDERATIONS
Following the same logic, when/if HSA distributions are needed or desired to cover medical expenses, such distributions should first come from the younger spouse’s HSA account. This leaves more funds available in the older spouse’s account, which once again is more likely to result in penalty-free — though not tax-free — distribution of funds needed to cover unqualified, non-medical expenses.

Of course, by prioritizing contributions to the older spouse’s HSA as outlined above, the younger spouse’s HSA would be kept to a minimum. Nevertheless, such funds still may exist because:

  • Contributions were made to the younger spouse’s HSA prior to marriage;
  • Contributions were made to the younger spouse’s HSA because the benefits of contributing to the older spouse’s HSA had not previously been made clear;
  • The couple wants to split HSA contributions to keep things “fair”;
  • Each spouse is covered by a self-only HDHP; or
  • The younger spouse is already 55 or older, and thus, must contribute at least the $1,000 catch-up contribution to their own HSA to maximize total family contributions.

Regardless of the reason a younger spouse’s HSA is funded, it generally makes sense to spend such dollars first, provided they are being used to pay for qualified medical expenses. Doing so of course preserves more of the older spouse’s HSA funds. Once both spouses reach age 65, the strategy can be discarded, as all future distributions from both spouses’ HSA accounts would receive the same tax treatment.

Ultimately, the takeaway for advisors is that when more than one HSA-eligible HDHP exists, determining who can contribute how much can be challenging. It also opens the door to planning opportunities that may not otherwise be available to clients. And it’s that latter point where advisors and planners are uniquely suited not just to alleviate client concerns, but to helping realize client goals.

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