To reduce the cost of medical care using HSAs, it is imperative that federal employees and retirees fully understand the rules. A previous column discussed HSA eligibility and what types of medical expenses can be paid from an HSA. This column discusses contributions to, and distributions from, HSAs. Federal employees and annuitants have access to HSAs through the Federal Employees Health Benefits (FEHB) program.
During 2018, an individual who are eligible to contribute to an HSA associated with a high deductible health plan (HDHP) may deduct from his or her federal income tax return (as an “adjustment to income”) up to $3,450 ($3,500 for 2019) for self-only coverage, or $6,900 for 2018 ($7,000 for 2019) for self and family, or self plus one health insurance coverage. If the individual is age 55 or older, then the individual can contribute each year an extra $1,000 to his or her HSA. Both the individual and the individual’s employer can make contributions to individual’s HSA with the total employee and employer contributions not exceeding the stated limits for that year.
With the FEHB program, the federal government pays on average 72 to 75 percent of premiums while employees/annuitants pay the remaining 25 to 28 percent of the FEHB premiums. Those employees and retirees who are enrolled in FEHB plans that are considered HDHP’s associated with HSAs will have a portion of the federal government’s FEHB premium contribution automatically deposited into the employee’s HSA. This is called the FEHB HSA “pass-through”. Two FEHB plans (GEHA and MHBP Consumer Option) HSA “pass-throughs” are summarized for 2018 in the following table: (the remainder of the plans may be downloaded here.)
The following examples illustrate how federal employees can get tax savings by contributing to their HSAs:
Example 1. Stuart, age 56, is a single Federal employee who is enrolled in the GEHA HDHP self only coverage during 2018. His monthly FEHB premium is $125.31 or $1,503.72 per year. From the table above, $62.50 per month of Stuart’s monthly GEHA premium or $750 per year, is coming from both Stuart’s and his agency FEHB contributions and contributed to Stuart’s HSA. Stuart’s contribution limit to his HSA for 2018 is $4,450 ($3,450 for a single person plus $1,000 since Stuart is over age 55). Stuart can contribute an additional $4,450 less $750 or $3,700 to his HSA for 2018. If Stuart is in a 22 percent Federal marginal tax bracket, then that means Stuart saves .22 times $3,700, or $814, in Federal income taxes during 2018 by contributing additionally to his HSA.
Example 2. Francine, age 48, is a married Federal employee who is enrolled in the MHBP-Consumer Option HDHP self plus one during 2018. Her monthly FEHB premium is $314.08 or $3,768.96 per year. From the table, $150 per month or $1,800 per year of the FEHB premium, is coming from both Francine and her agency and contributed to Francine’s HSA. Francine’s overall contributions limit to her HSA during 2018 is $6,900. She can contribute an additional $6,900 less $1,800, or $5,100, to her HSA for 2018. If Francine is in a 22 percent Federal marginal tax bracket during 2018, then she saves $1,122 (.22 times $5,100) by contributing an additional $5,100 to her HSA.
Returning to example 1, Stuart contributed to his HSA from his own money $3,700 between January 1 and July 31, 2018. The HSA earns about $200 in interest during 2018. Stuart withdrew $1,000 from his HSA to pay qualifying medical expenses during 2018. Stuart can deduct on his 2018 Federal income tax return (as an adjustment to income) the $3,700 contribution he made to his HSA. He does not pay tax on the $200 of interest he earned in his HSA during 2018 nor does he report it as income. Finally, he does not pay tax on the $1,200 he withdrew from HSA during 2018 to pay qualifying medical expenses during 2018.
Similar to IRAs, an individual has until April 15 to make an HSA contribution for the previous year. If the individual makes his or her HSA contribution between January 1 and April 15 of the following year, he or she must indicate that the contribution is to be applied to the prior year or it will automatically be applied to the current year.
Once during an individual’s lifetime, the individual may fund an HSA with a tax-free rollover from a traditional or a Roth IRA, referred to as a qualified HSA funding distribution. The rollover amount is limited to the maximum annual deductible contribution to the HSA. This may be beneficial if a person does not have the cash to put into an HSA.
Reporting HSA Contributions on One’s Federal Income Tax Return
Contributions made to a federal employee’s HSA by the employee’s agency are not included in the employee’s income. The only contributions that an employee reports as an adjustment to income are the employee’s contributions, or some other individual on behalf of the employees, separately to the HSA.
All employee contributions to an HSA are reported on IRS Form 8889, and as an adjustment to income on Form 1040. HSA custodians issue Form 5498-HSA, showing the amount of the contribution. An employer’s contribution to the employee’s HSA is shown on Form W-2, Box 12 with a Code “W”.
An individual will have excess contributions if the contributions to the individual’s HSA for the year are greater than the annual limit allowed for that year. Excess contributions are not deductible. But the IRS is somewhat lenient when it comes to correcting excess HSA contributions. If the excess contributions and any earnings associated with the contribution are withdrawn before the due date of the individual’s tax return, including extensions, then no penalty applies. However, the earnings on the excess contributions should be included in HSA owner’s income in the year in which the distribution is received, even if the distribution is used to pay medical expenses.
If the contributions are withdrawn after the due date of individual HSA owner’s tax return due date including extensions, then an annual 6 percent excise tax/penalty tax is imposed. IRS Form 5329 is used to compute the penalty and included with the annual Form 1040 filing.
Qualified distributions from an HSA are not reported on the HSA owner’s tax return.
Transfers of HSAs Pursuant to Divorce or Death
If a married couple gets divorced and an HSA is transferred to a spouse or former spouse pursuant to a divorce or separation agreement, then the transfer is not taxable. The recipient spouse becomes the beneficiary of the transferred HSA.
When an HSA owner dies and the surviving spouse is the designated beneficiary, then the surviving spouse is treated as the account beneficiary once the account is transferred. If the named beneficiary of an HSA is someone other than the owner’s spouse (such as a child), then the account will cease to be considered an HSA and is taxable to the beneficiary in the year of death. To avoid paying taxes on the HSA balance, the heirs can use the HSA account balance to pay for the decedent’s eligible medical expenses that were not previously reimbursed by the deceased’s HSA.
In short, HSAs are a great way for federal employees and annuitants to get tax deductions for medical expenses. This is especially important with the recent enactment of the Tax Cuts and Jobs Act of 2017, resulting in the majority of individual taxpayers no longer itemizing their deductions (filing Schedule A) and instead taking the standard deduction on their federal income tax returns. Even for those individuals who will itemize on their federal income tax returns for 2018, deductible medical expenses are only those that exceed 7.5 percent of adjusted gross income (exceeding 10 percent of adjusted gross income starting in 2019). Finally, HSAs are also a great way to save money in a tax-beneficial way to pay for future medical expenses, including long term care expenses and Medicare Part B premiums.