Health Savings Plans – Yet Another Wealth Shifting Benefit

Take-Away: Non-dependent children up to age 26 can contribute to a health savings plan if they are covered under their parents’ high deductible health insurance plan.

Background: Back in 2014 when the Affordable Care Act was passed, one key provision enabled children under the age of 26 to remain on their parents’ health insurance plan.

Health Savings Plan: If an individual is covered under a high deductible health insurance plan, that individual is permitted to contribute to health saving account, up to a maximum of $7,300 in 2022. The owner of such an account can take an above-the-line tax deduction for contributions to the plan.

Benefits: As has previously been covered in these missives, a heath savings plan provides many tax benefits, including: (i) contributions to the health savings account are income  tax deductible; (ii) the growth in the health savings account is tax deferred; and (iii) withdrawals from the health savings account are tax-free if they are used to pay for qualified  healthcare expenses.

Penalties: Note that if the funds held in the health savings account are distributed for any reason other than a qualified medical expense before age 65, the distribution is subject to a 20% penalty for that early withdrawal. If the account owner is over the age of 65, then no penalty is imposed on a distribution and it can be used for any reason, but if the distribution is not used to pay for qualified medical expenses, then the distribution will be taxed as ordinary income.

Spouses: If a family is covered by a family high deductible health plan, then the maximum amount that can be contributed to the family plan in 2022 is $7,300. Even if both spouses are covered under the same family high deductible health plan, the maximum aggregate amount that can be deducted by them for their contributions to their health savings accounts is $7,300, i.e. the spouses cannot ‘double’ the contribution(s) to $14,600- it is $7,300 for both of them. The spouses can, however, between the two of them allocate the $7,300 in whatever amounts between their separate health savings accounts.

Dependent Child: If a dependent child is covered under his/her parents’ high deductible health plan they, too, are not permitted to contribute separately to a their own heath savings account- the dependent child is subject to (covered by) his/her parents’ family maximum contribution to the health saving account of $7,300.

Non-dependent Child:  However, a non-dependent child who is covered under a family high deductible health plan is eligible to contribute to their own health savings account. Accordingly, a child under the age of 26 who is covered as part of their parents’ family high deductible health plan, but who is not claimed as a dependent on his/her parents’ income tax return for the calendar year, can contribute the maximum amount of $7,300 to their own health saving account. Like a 529 higher education account, anyone can fund an eligible individual’s health savings account; this, then,  enables the parents of the child to directly fund their child’s health savings account for the year, using up $7,300 of their annual exclusion gift exemption for the calendar year- the contribution to the child’s health savings account qualifies as a present interest since the child can access the contributed amount to the child’s account at any time.

Example: Dick and Jane are married. They have two adult children, Jack and Jill. Jack is age 22 who works full time. Jack is not eligible to be claimed as a dependent on Dick and Jane’s income tax return for 2022. Jill, age 20, is an undergraduate student who is still claimed as a dependent on her parents’ income tax return for 2022. Dick and Jane have a family high deductible health plan that satisfies the health savings account statutory conditions. Both Jack and Jill are covered by the family high deductible health plan. Dick and Jane can contribute a combined total of $7,300 to their respective health savings accounts in 2022; that amount can be split between their two accounts any way that they choose. Because Jack is not able to be claimed as a dependent by his parents, Jack can contribute $7,300 (the family high deductible health plan maximum) to his own health savings account and deduct the contribution on his own income tax return,  regardless of whether or not Dick and Jane contributed to their own health savings accounts. Alternatively, Dick and Jane can contribute to Jack’s health savings account, in addition to their own health savings accounts, as long as the total contributions made to Jack’s health savings account (regardless of who makes the contribution) does not exceed $7,300 in 2022- the maximum family high deductible plan limit. Moreover, regardless of whether the contributions to Jack’s health savings account are funded by Jack or by his parents, Jack is still able to deduct all contributions made to his health savings account on his own Form 1040 income tax return. As for Jill, since she is covered by Dick and Jane’s family high deductible health plan and she is also claimed as a dependent on her parents’ income tax return for 2022, Jill is not eligible to contribute to a health savings account of her own.

Payroll Deduction: Following the example, if Jack is going to contribute to his own health savings account, Jack should fund his account through payroll deductions whenever possible. The contributions set-up through payroll deduction are counted as pre-tax amounts that are not only excluded from Jack’s taxable income, but they will potentially avoid payroll taxes as well. While a contribution made directly by Jack to his individual health saving account may still be income tax deductible by him, he cannot retroactively receive a deduction for any payroll taxes that were already paid on the dollars that he contributed.

Conclusion: The short summary skips over a lot, like what constitutes a high deductible health plan?; when is an individual no longer eligible to be claimed as a dependent? etc. The point is simply that, like a 529 account, amounts that are contributed to a health savings account for a young adult on an income tax deductible basis will grow tax deferred, or later possibly tax-free if they are used to pay qualified medical expenses. If the young adult is healthy and does not access their account to pay current medical bills, a substantial amount can be accumulated in a health savings account that may continue to grow until the individual’s retirement years when medical expenses are expected to be substantially greater.