Tag Archives: HSA Funding

Contributing to HSA’s with a Cafeteria Plan

What are Cafeteria Plans

To understand Cafeteria Plans and HSA’s, it helps to understand the mechanisms for contributing funds to your Health Savings Account. There are four different ways to contribute to an HSA, all of which count towards your yearly contribution limit:

  1. Your employer contributes their money to your HSA. In this case, your employer gifts you funds directly into your Health Savings Account during the tax year. This is by far the best way to fund an HSA since the money is free and being given to you. Employer contributions count towards your yearly contribution limit but they are yours to spend as you like.
  2. You contribute after tax money to your HSA. This usually occurs by depositing cash or transferring funds between your bank account and your Health Savings Account. You have likely paid taxes on these funds (via payroll) so HSA tax Form 8889 helps you account for them and refund those taxes paid.
  3. You contribute from your IRA or Roth IRA. This is called a Qualified Funding Distribution and moves money from one tax advantaged investment account to your HSA. Do note that these contributions contain a Testing Period,
    requiring you to maintain HSA insurance.
  4. Your employer withholds your earnings pre-tax and contributes them to the HSA. This is an example of a what is called a cafeteria plan. These funds are yours (since they are being paid to you and are no longer your employer’s) and are a part of your paycheck. The employer is just enabling the contribution for you through their payroll system.

Cafeteria Plans are not unique to HSA’s; in fact, it is a general term used to describe pre-tax contributions made by your employer. They can be established for a variety of employee related savings or expenses.

A Cafeteria Plan is a reimbursement plan governed by IRS Section 125 which allows employees to contribute a certain amount of their gross income to a designated account or accounts before taxes are calculated.

Benefits of HSA Cafeteria Plans

There are numerous benefits of cafeteria plans that not only make your life easier, but actually end up saving money. Besides all of the advantages of savings in an HSA, here are some additional benefits that contributing via a Cafeteria Plan provides:

  • You pay less taxes. You read this right, Cafeteria Plans reduce the amount of taxes you pay. This is because payroll tax is not the only tax you pay each paycheck. In addition, you pay into other programs such as Medicare, Social Security, and any state taxes that are taken from your earnings. When you file Form 8889 as part of your tax return, you will only be credited for the income tax that was paid. The other taxes stay with Uncle Sam. Using a cafeteria plan allows you to make these contributions before all these payroll taxes hit it, allowing you to keep a larger slice of your earnings.
  • Disciplined savings. One of the hardest things about saving is actually putting aside the money to save. There is always something that comes up or something tempting you as a “more fun” use of the money. Saving via a Cafeteria Plan eliminates this because you automate your savings plan and the money is taken pre-tax. It never even hits your checking account as it goes straight to the HSA, preventing you from spending it and making sure you make your contribution.
  • Easier transactions. I never had the luxury of a cafeteria plan so each month I had to initiate a transfer to my bank to make the contribution. Having this taken care of for you reduces the amount of work you have to do and transfers you make with your money.

If you are presented the option for contributing to an HSA via cafeteria plan you should definitely consider it, based on the benefits above. Their main drawback is decreased flexibility in changing HSA contributions, since they are happening automatically from your paycheck. For example, it may take time to adjust your HSA contribution amount during the year. There may be a lockout period, a delay before it takes effect, and you at least have to talk to HR to make the change. You should evaluate how your specific payroll plan handles changes to HSA contributions via a cafeteria plan and assess whether that is suitable to your needs before signing up.

Reporting Cafeteria Plan Contributions on Form 8889

The biggest mistake people make with Cafeteria Plan contributions and filing HSA tax Form 8889 is putting them on Line 2. Line 2 is where contributions you personally made (#2 above) are totaled and used to reduce your taxable income. This has the effect of making your contributions tax free. You can see that by adding Cafeteria Plan contributions to this line, you are “double dipping” because you never paid taxes on those contributions to begin with. Line 2 has a disclaimer that calls this out:

Do not include employer contribuitons, contributions made through a cafeteria plan, or rollovers in Line 2 (see instructions)

Form 8889 Line 2

Due to the IRS’ confusing wording, most people don’t even know they are contributing through a cafeteria plan or what one is. Thus, they end up making a mistake on Form 8889 and potentially receiving a call from the IRS.

The correct place to put contributions made through a cafeteria plan is on Line 9 of Form 8889, which is called “Employer Contributions”. This makes sense because, in our discussion above, we saw how cafeteria plan contributions look a lot like employer contributions. There is no taxes being paid on both of these contributions, it is just a matter of whose money is being contributed. Again, the IRS doesn’t help us with Form 8889 because they describe the line as “Employer contributions made to your HSA for 2017”.

Form 8889 Line 9

If you look into the Form 8889 instructions, you can see that this is the exact spot where Cafeteria Plan contributions should go:

Form 8889 Line 9 Instructions

Doing so will ensure the amount that travels over to your 1040 form is the correct amount to deduct.

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How to Rollover HSA Funds

At some point you may find yourself with multiple Health Savings Accounts that you wish to combine or transfer money between. While the actual transaction is easy to accomplish, there are potential tax implications per the IRS, as this transaction ends up on Form 8889, so it is best to play by the rules and do it correctly. This article will outline those rules to rollover your HSA.

HSA Rollover Definition

The IRS defines an HSA rollover as:

A rollover is a tax free distribution (withdrawal) of assets from one HSA or Archer MSA that is reinvested in another HSA of the same account beneficiary.

Note they define a rollover as a distribution that occurs in an effort to move money between Health Savings Accounts that belong to the same owner. However, the key word is distribution which we will get to shortly. They go on to say:

Generally, you must complete the rollover within 60 days after you received the distribution.

This language confirms that you are actually receiving the money, probably in the form of a check, from the originating HSA trustee. You then have 60 days per the IRS to deposit that money in a corresponding HSA to avoid penalty. One last rule from the tax man:

An HSA can only receive one rollover contribution during a 1 year period.

The IRS puts a limit on the number of HSA rollovers that can occur during a year, which is not necessarily a calendar year. But they note that this restriction is on the receiving HSA account, not the originating account.

Direct Transfer from HSA to HSA

It is important to note that rollovers that occur directly between HSA trustees are not considered rollovers. For example, if you instruct HSA Account 1 to transfer $500 to HSA Account 2, and they transfer directly without you ever seeing it, this is not a rollover. Instead, the IRS deems this a transfer:

If you instruct the trustee of your HSA to transfer funds directly to the trustee of another of your HSAs, the transfer is not considered a rollover. There is no limit on the number of these transfers. Do not include the amount transferred in income, deduct it as a contribution, or include it as a distribution on Form 8889.

Thus, the same rules do not apply to transfers and HSA rollovers. Transfers are much more flexible and frequent. Likely, the IRS imposes tight rules on Rollovers since they “lose sight” of the money for a while, which opens the door for non qualified HSA spending. The key test is in the distribution, determined by whether you physically receive the HSA funds (check) to redeposit in another HSA.

HSA Rollover vs Transfer Comparison

This table clarifies the difference between HSA rollovers and transfers:

Rollover Transfer
Funds transferred to you, then to receiving HSA directly to receiving HSA
Time to complete 60 days None (instant)
Form 8889 impact Include in 14a and 14b Not included
Frequency Limits Once every 12 months No limit
Affects HSA Contribution Limit No No
Included in income No No
Deductible No No
Difficulty medium easy

HSA rollover rules

To summarize the rules for rolling over your HSA:

  1. Initiate the distribution from your originating HSA trustee, and they will send you a check
  2. Upon receiving the HSA funds, redeposit them with the receiving HSA trustee within 60 days
  3. You may only make one rollover during each 1 year period, beginning on the date you make the deposit.
  4. Record this as an HSA rollover on Form 8889, lines 14a and 14b.

Should I transfer or rollover my HSA?

In general, I would opt for a direct transfer of your HSA. This is done by instructing your HSA trustee to move money to another HSA trustee. The reason is it is much simpler for you to execute and takes less time. You don’t have to wait for the check, spend time depositing it in your other HSA, and then remember and figure out how to report it at tax time on HSA Form 8889. Plus, you can do as many of these transactions as you wish during the year.

How to report HSA rollover to the IRS

One disadvantage of a true HSA rollover is that you will need to report it on IRS tax Form 8889. When properly accounted, a rollover will not adversely affect you in terms of taxes, penalty, or contribution limit; it is a totally legitimate transaction. Instead, it is more of a nuisance as you have to remember to report it to satisfy the IRS and correctly file Form 8889.

On Form 8889, you will need to include the amount of your HSA rollver distribution on both:

  • Line 14a – Total distributions you received from all HSA’s
  • Line 14b – Distribution included on line 14a that you rolled over to another HSA.

Here is an example of what Form 8889 looks like for 2015 with only a $1000 HSA Rollover:

form8889_hsa_rollover_line_14

The above was prepared by EasyForm8889.com, which asks simple questions like this to complete HSA Form 8889:

EasyForm8889.com HSA Rollover questions

Transfer your HSA to a New Employer

Depending on how your employer’s HSA is setup, there may not be any work to transfer your HSA to a new employer. In one situation, you go to a new employer who offers HSA eligible insurance, but does not contribute or offer cafeteria plan (removed from your paycheck) contributions. In that case, you manage the HSA yourself, and can maintain the account at whatever financial institution you wish.

However, if your employer is making contributions or your contributions will be made through a cafeteria plan, you may need to transfer funds to your new HSA. You have the option of receiving and redepositing (Rollover) the HSA funds, or just initiating a trustee to trustee transfer for the HSA funds. Either one will work, but note the advantages above of the simpler transfer method. Generally, this will be a good idea to minimize your account fees and manage your HSA in one spot.

HSA rollover IRA to HSA

If you wish to rollover IRA (or even 401(k)) funds to your HSA, this is not considered a rollover, but instead a Qualified HSA Funding Distribution. Please see the aforementioned article for more information, as there are more restrictions and rules regarding this type of transfer.

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Your Adult Children on your Family Insurance can have their own HSA

Overview

Did you know that if your adult children are covered by your HSA eligible family health insurance, they likely can open their own HSA? You read that correctly. A common misconception is that only the policy holder can open a Health Savings Account. This is not true, as a review of the HSA guidelines reveals that this restriction to the policy holder (read: you) does not exist. Said another way:

Every independent (tax) person on an HSA Family Plan can open their own HSA and contribute the full year amount.

With the (un)Affordable Care Act mandating that children be allowed to remain on parent HSA insurance plans until age 26, more and more adult children are opting for this and staying on parent plans longer. The good news is, if they are no longer your tax dependent, they can open their own HSA, and anyone can contribute to another’s HSA account. That means that even if junior is in university and making no money, he can still receive up to $6,750 into his HSA account for 2015 from his loving mom or dad, or grandparent, or whoever.

The mechanics of your child having an HSA

So how does this work? The mechanics lie within the definition of and eligible individual, or who can open an HSA, provided by friendly Publication 969. An eligible individual is defined as one who:

  1. is covered under a High Deductible Health Plan (HDHP)
  2. has no other health insurance
  3. is not enrolled in Medicare
  4. cannot be claimed as a dependent on someone else’s tax return (important)

The key one is really #4, in that an HSA holder cannot be claimed as a dependent on someone else’s tax return. Unfortunately, due to this you cannot open an HSA for your young child or children and begin saving for them. You have to wait until they are filing their own taxes. Other than that, the first 3 should almost always apply to adult children. If all 4 of these are true, your adult child qualified as an eligible individual even though they are on your health insurance. That means they can open their own Health Savings Account and begin saving – or you can begin saving for them.

Child HSA Example – Simple

Let’s assume that you are married and have one child who is not longer your dependent. To keep things simple, assume you have had HSA eligible family insurance for everyone for a while (so no Last Month Rule effects) and you are smart and have your own HSA, but your spouse does not. For 2016, the contribution limit for family insurance is $6,750. As such the following maximum HSA contributions are allowed:

  • You – $6,750
  • Child – $6,750

Note that the above amounts end up in 2 different Health Savings Accounts – one for you, and one for your adult child.

Children HSA Example – Complicated

Now assume that you are married and have two adult children and everyone is on your HSA eligible family insurance. Let’s assume you began that insurance on July 1st (exactly mid year) so the Last Month Rule is eligible for this year. Both you and your wife are smart and have your own separate HSA’s, and thus due to Line 6 of Form 8889 you must share the maximum contribution amount between these two accounts. Note that this does not affect your children. For 2016, the contribution limit for family insurance is $6,750. As such the following maximum HSA contributions are allowed:

  • You & spouse – contributions to both HSA accounts cannot exceed $6,750
  • Child 1 – $6,750
  • Child 2 – $6,750

A couple things of note. You and your spouse are limited to a $6,750 between your accounts (so $3,375/$3,375, or $6,750 / $0 would both work). Also notice that your children can each contribute up to the family contribution limit, separate from you and your spouse’s limitation. This is the big advantage here.

An important note: it is my duty to explain the Last Month Rule here. Since coverage began in July, you are freely allowed to contribute 6/12 x $6,750 = $3,375 for the year for each of these accounts. However, you have the option to use the Last Month Rule and contribute the full $6,750 to each account, but you must maintain coverage for the following year. Otherwise, any amount over contributed to each account can be taxed and penalized.

Reasons to establish Health Savings Accounts for your children

There are a wide number or reasons to establish and contribute to an HSA for your adult children. Children at this age (18-26) are just beginning to understand and manage their finances and establishing good habits can last a lifetime. Additionally, due to the nature of US healthcare you want to offer them every advantage they can get. Having a pile of cash to fall back on for medical care as they go through their 20’s can provide peace of mind as well as incentive to actually go and visit the doctor if something is wrong. It helps remove the money problem from medical decisions. In some ways, it is analogous to opening an IRA for them and contributing, but arguably, more practical.

Here are some additional advantages:

  • Emphasize importance of saving
  • Teach them the value of money and how to navigate US healthcare system
  • Encourage them to manage their finances wisely
  • Provide a financial safety net as they begin their career
  • Allow them to pay for healthcare as it arises
  • Contributions provide a tax deduction on Form 8889

That’s a lot of Filing Form 8889

One thing of note, is that you must file a Form 8889 for every HSA account that receives contributions or spends money, every year. That means that everyone with an HSA – you, your wife, any children – all need to fill out this tax form when filing you taxes each year. Being children, and new to taxes and HSA’s, they are prone to avoid or miss this requirement and incur financial penalty. Help them avoid this by explaining tax requirements; you can even see an article on how to file Form 8889.