HSA Last Month Rule: How It Works and What You Need to Know
Understand the HSA Last Month Rule, its impact on contributions, and how to manage mid-year changes effectively.
Health Savings Accounts (HSAs) offer a tax-advantaged way to save for medical expenses, making them an attractive option for many individuals. However, understanding the rules governing HSAs is crucial to maximizing their benefits.
Eligibility Criteria for Coverage
To qualify for an HSA, individuals must be enrolled in a High Deductible Health Plan (HDHP). As of 2024, the IRS defines an HDHP as a plan with a minimum deductible of $1,600 for self-only coverage and $3,200 for family coverage. Maximum out-of-pocket expenses cannot exceed $8,050 for self-only coverage and $16,100 for family coverage. These thresholds establish eligibility and ensure compliance with HSA regulations.
Individuals must not be covered by any non-HDHP health plan, including Medicare, to maintain eligibility. This restriction ensures the tax advantages of HSAs are available only to those reliant on high-deductible plans. Additionally, individuals cannot be claimed as dependents on another person’s tax return, preserving the account holder’s financial independence.
The Last Month Rule allows individuals eligible on December 1st to be treated as eligible for the entire year. This provision enables full-year contributions, even if eligibility began partway through the year. However, it requires maintaining HDHP coverage through the end of the following year, known as the “testing period,” to avoid tax penalties.
Application of the Last Month Rule
The Last Month Rule permits individuals eligible on December 1st to contribute as though they were eligible for the entire year. For example, if someone becomes eligible in November, they can still contribute the full annual limit for that year, even with only a short period of HDHP coverage. This flexibility benefits those who transition to an HDHP late in the year.
However, individuals must maintain HDHP coverage through December 31st of the following year to avoid penalties. Contributions made under the Last Month Rule will be subject to income tax, and a 10% penalty will apply to amounts exceeding the prorated contribution limit for the months of actual eligibility.
Mid-Year Enrollment and Transitions
Mid-year enrollment and transitions involving HSAs require careful planning. Changes in employment, marital status, or health plan coverage can affect HSA contributions and eligibility. For those who switch to an HDHP mid-year, contributions are prorated based on the number of months covered by an HDHP. This is calculated by dividing the annual contribution limit by 12 and multiplying by the months of coverage.
Transitioning between health plans requires attention to the “testing period” requirements. Maintaining qualifying coverage after transitioning into an HSA-eligible plan ensures full benefits from the Last Month Rule. Conversely, leaving an HDHP before the year’s end can trigger tax penalties if contributions exceed prorated limits. Referencing IRS guidelines, such as those in IRS Publication 969, is essential for compliance and maximizing HSA benefits.
Calculating Contribution Limits
HSA contribution limits depend on annual caps and personal circumstances. For 2024, the IRS has set maximum contribution limits at $3,850 for individuals and $7,750 for families, with annual adjustments for inflation. Individuals aged 55 and older can make an additional $1,000 catch-up contribution to bolster savings for retirement.
Employer contributions count toward the total limit. For instance, if an employer contributes $1,000 to an HSA, the individual’s personal contribution limit decreases by that amount. Planning is necessary to maximize tax-advantaged savings, particularly when employer contributions are involved.
Handling Excess Amounts
Excess contributions to an HSA require immediate action to avoid tax penalties. These overages can result from miscalculations, overlapping employer contributions, or changes in eligibility. The IRS imposes a 6% excise tax on excess amounts for each year the surplus remains unaddressed, as specified in Section 4973 of the Internal Revenue Code.
To resolve excess contributions, individuals can withdraw the surplus and any associated earnings before the tax filing deadline (typically April 15th of the following year). For example, if someone contributed $500 over the limit in 2024 and earned $10 on that amount, they must withdraw $510 to avoid the excise tax. The withdrawn earnings are subject to income tax and must be reported on Form 1040. Proper categorization by the HSA custodian is critical for accurate reporting.
If the excess is not withdrawn by the deadline, the 6% excise tax will apply annually until the surplus is corrected. Alternatively, individuals can offset the excess by reducing contributions in subsequent years, though this approach may not be ideal for those aiming to maximize savings. Proactive management and clear communication with HSA custodians can help mitigate risks and ensure compliance with IRS regulations.