Reaping Tax Benefits from Health Savings Account Contributions

An IRS-approved “adjustment to income” ranks as one of the more valuable deductions resulting in the lowering of an individual’s taxable income and federal income tax liability. An adjustment to income not only lowers an individual’s taxable income, but also could result in an individual being eligible for certain tax deductions or tax credits, such as a tax deduction for student loan interest or an education tax credit.

An example of an adjustment to income is a Health Savings Account (HSA) contribution. Those federal employees enrolled in a Federal Employees Health Benefits (FEHB) program high deductible health plan (HDHP) associated with an HSA can make individual contributions to their HSAs. These contributions are considered an adjustment to income and result in tax savings for the year the contributions are made.

SEE ALSO: Why a Health Savings Account Can Be Valuable for Federal Employees & Retirees

Who is Eligible to Contribute to an HSA?

A federal employee or retiree is eligible to contribute to an HSA if he or she meets the following four requirements:

1. Is enrolled in a qualified high-deductible health plan (HDHP) offered through the FEHB program.

2. Not also covered by any other health plan unless it is also an HDHP.

3. Not enrolled in Medicare.

4. May not be claimed as a tax dependent on another person’s income tax return.

Limit on HSA Contributions

SEE ALSO:  IRS Announces Big Increases in Health Savings Account (HSA) Contribution Limits for 2024

Each year, the IRS imposes limits on annual HSA contributions. The amount that a federal employee or retiree can contribute annually to the employee’s or retiree’s HSA depends on the employee’s or retiree’s:

(1) Type of HDHP coverage (self only or self and family); and

(2) Age.

Also, the amount that can be contributed to the HSA will depend on the date that an employee or a retiree ceases to be eligible to contribute to an HSA.

The following example illustrates:

Example 1. Laura, age 64, is enrolled in an FEHB program HDHP during 2024. Laura will become age 65 in November 2024 and plans to retire from federal service on November 30, 2024. Laura will enroll in Medicare in early January 2025. Laura will no longer be eligible to contribute to her HSA as of January 1, 2025.

The following table presents the 2023 HDHP minimum deductible limits, maximum annual out-of-pocket expenses, and HSA contribution limits:

Table 1. 2023 Annual HDHP Limits and Maximum HSA Contributions

In the case of a married couple in which both spouses are age 55 or older and not enrolled in Medicare, each spouse’s contribution limit is increased by the additional contribution. If both spouses meet the age requirement, the total contribution under self and family coverage during 2023 cannot exceed $9,750. Each spouse can make an additional $1,000 contribution to his or her own HSA.

The following example illustrates:

Example 2. Allan, age 58, and Beth, age 53, are married and both are federal employees. Allan is enrolled in an HDHP associated with an HSA. He has self plus one coverage (himself and one child under age 26). Beth is enrolled in an HDHP associated with an HSA. She has self plus one coverage (herself plus one child under the age of 26).
Allan and Beth can split the family contribution limit of $7,750 equally or they can agree on a different division. If they split the $7,750 equally, then Allan can contribute $3,875 to his HSA (one half of $7,750) plus a $1,000 additional contribution for a total of $4,875. Beth can contribute the other $3,875 to her HSA for 2023.

Amount of Federal Employee HSA Contributions Reduced by Agency Contribution

Those federal employees who are enrolled in an HDHP associated with an HSA automatically have a portion of their HDHP premiums deposited bi-weekly into their HSA. Federal employees pay on average 25 to 28 percent of the FEHB program health plan premiums. Their agencies pay the other 72 to 75 percent of the FEHB program health plan premiums. A portion of the agency paid premium HDHP premiums (72 to 75 percent) are also automatically deposited into the HSA.

The total amount of FEHB program HDHP premiums (employee and agency portions) that are automatically deposited into an employee’s HSA every pay period is called the “premium – pass through”. The “premium pass through” is shown on an employee’s annual W2 statement in Box 12 with a Code “W”. The amount shown in Box 12 Code W reduces the amount that an employee can make on his or her own via an “adjustment to income”. The maximum employee contributions for the year 2023 are shown in Table 1.

The following example illustrates:

Example 3. Jessica, age 35, is a federal employee with self only coverage in an HDHP associated with an HSA. Jessica received her 2023 W2 statement. In Box 12 of her W2 statement is a code “W” with an amount of $2,000. This means that Jessica’s HSA “premium pass-through” is $2,000.
Since Jessica’s total HSA contribution during 2023 is limited to $3,850 (Table 1), Jessica can contribute a maximum $3,850 less $2,000, or $1,850, to her HSA between now and April 15, 2024. The $1,850 contribution is an “adjustment to income” and reduces Jessica’s 2023 gross income by $1,850.

HSA Contributions Via Gift

Another individual (a relative or a friend) can make a cash gift to the HSA owner that the HSA owner can contribute to his or her HSA. The HSA owner is able to deduct the amount of the gift as an adjustment to income. The gift further reduces what the HSA owner can contribute for the year. The following example illustrates:

Example 4. Same facts as Example 3 except that Jessica’s mother gifts her $500. Jessica’s deposits the $500 into her HSA. Jessica can contribute a maximum of $1,350 ($3,850 less $2,000 less $500) to her HSA between now and April 15, 2024.

The following table summarizes the four types of HSA contributions that federal employees who are enrolled in an HDHP associated with an HSA can make:

All HSA owner contributions made to an HSA are reported on IRS Form 8889 (Health Savings Accounts). A portion of IRS Form 8889 is shown here:

The following example illustrates the total tax savings (federal and state income taxes, FICA and Medicare Part A payroll taxes) incurred by a federal employee who made the maximum HSA contribution for 2023:

Example 5. Micheal is a federal employee and married. During 2023, Michael was enrolled in an HDHP associated with an HSA. He is age 56 and has self and family coverage. Other relevant information related to Michael:

2023 gross salary: $150,000

Employee “premium-pass-through”: $1,000 (reported on 2023 W2)
Employer “premium-pass-through”: $2,500 (reported on 2023 W2)

Maximum 2023 HSA contribution: $8,750 ($7,750 + $1,000)

Michael’s HSA contribution (via gift from third party): $1,000

Michael’s maximum HSA contribution: $4,250 (from own funds) ($8,750 less $1,000 less $2,500 less $1,000)
(from own funds)

Michael’s federal marginal tax bracket: 22 percent
Michael’s state marginal tax bracket: 8 percent

Special Once-In-A-Lifetime IRA Transfer to HSA

Once per lifetime, an individual traditional IRA or a Roth IRA owner may make a tax-free trustee-to-trustee direct transfer to his or her HSA. The transfer cannot come from a SEP-IRA or a SIMPLE IRA unless no current contributions were made to the SEP or SIMPLE IRA for the same plan year.

The maximum qualified HSA funding that comes from the IRA depends on the type of HDHP coverage (self only or self plus one/self and family) the HSA owner has on the first day of the month in which the contribution is made and his or her age as of the end of the tax year in which the transfer is made. The distribution must be made directly by the trustee of the IRA to the trustee of the HSA.

Note that the IRA distribution and direct transfer to the HSA is:

(1) Not deductible for income tax purposes; and

(2) Reduces the amount that may be contributed to the HSA.

The qualified HSA funding distribution is shown on Form 8889 line 10 for the year in which the IRA distribution is made, as shown here:

A traditional IRA or a Roth IRA owner can only make one qualified HSA funding distribution during his or her lifetime.