Tag Archives: Change in Coverage

Paying for Health Insurance Premiums with HSA Funds

This question was submitted by HSA Edge reader Laura. Feel free to send in your question today to evan@hsaedge.com.

I was forced into early retirement and the company COBRA was outrageously expensive. I went to the marketplace and found a plan with Anthem. I have been paying for the coverage with HSA funds. Is this an eligible (covered) expense? I am not receiving unemployment benefits.

How to Pay for Premiums with HSA

It is unfortunate that HSA funds cannot be used for insurance premiums except in extenuating circumstances involving job loss. While it is possible this law will change in the future, currently it is not the case. Even so, the rules for paying insurance premiums while unemployed are strict. Long term care and Medicare are included, as is continuing health coverage such as COBRA. If those don’t apply, you can pay for health insurance while on unemployment benefits from the state/federal government. This clause explicitly requires being on state/federal unemployment compensation. Unfortunately this is usually the only real option as continuing coverage via employer sponsored COBRA insurance is excessively expensive.

The IRS spells this out when insurance premiums are considered qualified medical expenses in IRS Publication 969:

Insurance premiums. You can’t treat insurance premiums as qualified medical expenses unless the premiums are for:

  • Long-term care insurance
  • Health care continuation coverage (such as coverage under COBRA)
  • Health care coverage while receiving unemployment compensation under federal or state law
  • Medicare and other health care coverage if you were 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap)

That leaves most people going back to the market place for coverage. In theory, you can pay for any health insurance premium using HSA funds, but you must be unemployed. Specifically these premiums are a qualified medical expense if you are receiving federal or state unemployment compensation. I believe they do this as their filter for who is truly unemployed seeking assistance. So if you lose your job, you can sign up for any health insurance you want, and if you are receiving unemployment benefits, you can pay for the expenses with your HSA. This is part the strategy of building up your HSA to use as an unemployment safety net, as it does provide some flexibility for your funds if you lose your job.

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HSA Expenses Incurred Before Opening Account

Opening an HSA

The timing of opening your Health Savings Account –going to a bank and actually creating an account in your name– ends up being quite important for your finances. The reason is the date you open your Health Savings Account is the date that qualified medical expenses begin for you. Any medical care incurred before you open your HSA does not count as a qualified medical expense. Said another way, you cannot use pre-tax dollars to purchase medical care that occurred before you actually created your Health Savings Account. Per IRS Form 969:

For HSA purposes, expenses incurred before you establish your HSA aren’t qualified medical expenses. State law determines when an HSA is established.

It is actually easier than most people think to open up a Health Savings Account. The main difficulty comes in choosing a provider. Things I look for are low fees, online banking ability, phone app, and investment options. Once you find the financial institution you wish to bank with, you need to apply for the account. While this sounds painful, it is actually quite simple. To open the HSA, they will need standard information such as name and address, and also some information about your health insurance. They will use this to validate that you do in fact have an HDHP, and also use your self-only or family coverage for a rough determination of your contribution limit for the year. They use that information to help prevent contribution mistakes and it aides in generating Form 5498-SA and Form 1099-SA. Once you submit that, you are all set, and you can begin making contributions to your HSA.

The cost of not opening an HSA

You must overcome the tendency to delay opening your HSA, as it could come back to bite you. If you have HSA eligible insurance but have not yet opened a Health Savings Account you may be on borrowed time, as any medical expense incurred cannot be paid with pretax dollars. The risk to you can be equal to the (amount of expense) x (your tax rate). Even a $100 expense for someone in a 25% tax bracket will end up costing them $33 extra. Said another way, it takes $133 dollars taxed at 25% to pay for a $100 medical expense. For an HSA holder, they only need to earn $100 to pay for the expense. Multiply this expense by 10 and this $1,000 expense will cost you $333 in extra tax dollars paid, all of which is completely avoidable. This money adds up and there is no reason to pay it with the generous HSA contribution limits.

Effect on Contribution Limit

While opening the actual Health Savings Account begins the process of allowing qualified medical expenses, it does not have an effect on your contribution limit for the year. Your contribution limit is based on when you are an eligible individual. So you can have HSA eligible insurance and be allowed to contribute to your not-yet-open HSA. Of course, you will need to open that Health Savings Account before you make that year’s contribution.

Take the following scenarios as an example:

HSA coverage begins HSA opened QME begin Contribution Limit Last Month Rule?
January 1st June 1st June 1st Full N/A
January 1st January 1st January 1st Full N/A
June 1st June 1st June 1st 1/2 up to full Optional
June 1st October 1st October 1st 1/2 up to full Optional

As you can see above, delaying in opening your HSA can prevent you from paying for medical care from your HSA. If you plan on contributing to an HSA you might as well open the account as soon as possible, to take advantage of paying for medical care tax free with the HSA.

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Deciding to Use the Last Month Rule for New HSA Coverage

This question was submitted by HSAedge reader Beth. Feel free to submit your question today to evan@hsaedge.com.


I have an employer that is implementing an HSA eligible plan on 4/1/2017. Of course, everyone wants to invoke the “last month rule” but we keep telling them that is not a best practice due to the possible tax implications should they switch plans etc. Can you give some examples of “problems” with someone enrolling 4/1/2017 invoking the last month rule and not remaining covered during the testing period?

That is certainly a good question and applies to many people who begin HSA coverage mid year. As I see it, they have two options in front of them – reduce their contribution pro rata for the months covered, or contribute the full year amount by using the Last Month Rule. The former is safe with no risk of paying taxes and penalties in the following year, while the latter allows you to contribute more in the current year.

Contribute Only for Months Covered to Lower Risk

Let’s be clear on the situation facing your team. With coverage beginning on April 1st 2017, they will have 9 months of HSA eligible coverage for 2017. Stated differently, they are covered by a HSA eligible insurance for 75% (9/12) of 2017. Since they only have partial year coverage, the amount they can safely contribute to their HSA that year is reduced pro rata. In this case, they can contribute 75% of the contribution limit based on their coverage type and age, no strings attached. For 2017, these amounts are:

  • Self only: $3,400 x 0.75 = $2,550
  • Family: $6,750 x 0.75 = $5,062.50
  • if 55+: $1,000 x 0.75 = $750 in addition to above

So they can contribute those amounts, free and clear, and be finished. Making contributions for the months you had HSA eligible coverage means you never have to worry about taxes or penalties relating to the Last Month Rule.

Contribute More Using Last Month Rule

However, they may be aware that there is a provision called the Last Month Rule that states that if they have HSA eligible insurance on December 1st of a year, that they can contribute the full year contribution limit. Assuming they maintain HSA eligible coverage until December, this election allows them to contribute 100% of the $3,400 or $6,750, instead of just 75%. However, what they may not know is there is a catch. By taking advantage of the Last Month Rule, they are bound by the terms of the Testing Period. This basically states that they need to maintain HSA coverage for the following 12 months, or the amount they contributed above their calculated (75%) amount will be taxed and penalized.

People fail the Testing Period more often than you think, and it causes tax problems when they go to file Form 8889. It is difficult to predict over a year in advance what your insurance situation will be. Some events are not foreseeable. Other people don’t even know what the Testing Period is! For example, here are some common reasons people’s insurance changes and they fail the Testing Period:

  • Change jobs and get new insurance
  • Lose job and lose insurance
  • Change to a non HSA-eligible plan
  • Go onto spouse’s insurance
  • Change to state health insurance (Obamacare)
  • Go onto Medicare
  • Start taking Social Security

Any of the above will likely cause you to fail the Testing Period and owe taxes and penalties.

Calculating Taxes and Penalties for Failing the Last Month Rule

If you fail the Testing Period, you will have to go back and do a bunch of work for Form 8889. The IRS will have you compare the amount you contributed ($3,400 or $6,750) to the amount you could have contributed without the Last Month Rule ($2,550 or $5,062.50). The difference will be added to your taxable income for the current year and assessed a 10% penalty.

Here are the tax and penalty calculations for our previous examples. Assume you had 9 months of coverage and used the Last Month Rule to contribute the full 2017 contribution limit:

  • Self only: $3,400 – $2,550 = $850 added to income (taxed); $85 penalty
  • Family: $6,750 – $5,062.50 = $1,687.50 added to income (taxed), $168.75 penalty
  • if 55+: $1,000 – $750 = $250 added to income (taxed); $25 penalty in addition to above

As you can see, failing the Testing Period means writing Uncle Sam a check for taxes and penalties. For some people, this is a bad bet because they change insurance frequently, or the taxes / penalties / headache aren’t worth the additional risk. They contribute a little less this year but no big deal. For others, this is a good risk because they have stable insurance. It allows them to contribute more to their HSA and reduce current year taxes. There is no “right” answer and it is up to the individual HSA holder to decide.