Can You Reimburse New Family Members' Expenses with Old HSA Contributions?
By William G. (Bill) Stuart | Originally posted by Health Savings Academy
This column is an excerpt (Question 109) from a book to be published later this year to help guide account owners, employers, benefits managers, and administrators understand Health Savings Account compliance issues. The format consists of a common question, an explanation in easy-to-understand English (often with an appropriate example), and a citation from government documents to support the answer. The book is designed to inform. It is not a legal document, and the contents should not be construed as legal advice.
Question: I funded a Health Savings Account through my company for several years and built a $6,000 balance. Then, I married and enrolled on my wife’s non-HSA plan. Now we have two children. Can I reimburse these family members’ qualified expenses tax-free from my Health Savings Account? They weren’t my spouse or tax dependents at the time that I contributed to my account.
Answer: Yes. You can reimburse your spouse’s and tax dependents’ qualified expenses tax-free from your Health Savings Account if the family member who incurs the expense is your spouse or your tax dependent at the time of the qualified expense. Remember that they do not have to be covered on your medical plan for you to reimburse their qualified expenses tax-free (see Question 102).
This concept reinforces the power of a Health Savings Account for a young person. Younger people, on average, incur lower medical expenses than older people. This situation doesn’t hold universally – a young adult may have a chronic condition, an acute illness, or an active lifestyle that leads to injuries – but on average it remains true. For those young (and not-so-young) people who typically incur low out-of-pocket medical costs, enrolling in HSA-qualified coverage and funding a Health Savings Account presents some real financial advantages:
Lower premiums. The price of coverage is lower than most plans, whether you purchase coverage through your employer (who pays a large portion of the premium, either directly with emplo9yer-sponsored coverage or via stipend through an Individual-Coverage Health Reimbursement Arrangement, or ICHRA) or in the nongroup market (where you pay the entire premium less any advance-premium tax credits through a federal- or state-facilitated public marketplace). If you usually don’t incur high medical expenses, why pay your insurance company more money to buy down a deductible that you don’t reach most years.
A painless source of funds. You can direct your premium savings (and other funds) to your Health Savings Account. If you work for an employer who has established a Cafeteria Plan (also called a Section 125 Plan to reflect the relevant section of the Internal Revenue Code) so that your payroll deductions for premiums are pre-tax (nearly all employers offer this benefit), you can deposit your premium savings into your account to maintain your tax break. Contributions above that amount further reduce your taxable income dollar-for-dollar.
Lifetime benefits. You can build an emergency (or non-emergency) medical fund to reimburse qualified expenses tax-free for the rest of your life. If you contribute $1,000 more to your Health Savings Account than you withdraw each year and earn a 5% average return on your investment, you build a balance of $12,900 after 10 years, $33,900 after 20 years, and $68,100 after 30 years. Increase the figure to $1,200 (about $8 more per biweekly pay period) and the figures rise to $15,500, $40,700, and $81,700. A small spending deferral, combined with compounded growth, can produce substantial medical equity to spend in retirement.
If you marry and start a family, you can expect your qualified expenses to increase. If you continue to fund a Health Savings Account and contribute at least as much as you withdraw each year, the balance that you built continues to grow. Incidentally, industry surveys show that account balances among active Health Savings Account contributors increase by about $400 annually. This figure, though, is subject to the caveat that you hear so often: Individual results may vary. You have control over how you allocate your income and other resources, and your decisions can result in a lower or higher average annual balance increase.
IRS Notice 2004-2:
Q-26. What are the “qualified medical expenses” that are eligible for tax-free distributions?
A-26. The term “qualified medical expenses” are expenses paid by the account beneficiary, his or her spouse or dependents for medical care as defined in section 213(d) (including nonprescription drugs as described in Rev. Rul. 2003- 102, 2003-38 I.R.B. 559), but only to the extent the expenses are not covered by insurance or otherwise. The qualified medical expenses must be incurred only after the HSA has been established. For purposes of determining the itemized deduction for medical expenses, medical expenses paid or reimbursed by distributions from an HSA are not treated as expenses paid for medical care under section 213.
IRS Notice 2004-50:
Q-36. If an account beneficiary’s spouse or dependents are covered under a non-HDHP, are distributions from an HSA to pay their qualified medical expenses excluded from the account beneficiary’s gross income?
A-36. Yes. Distributions from an HSA are excluded from income if made for any qualified medical expense of the account beneficiary, the account beneficiary’s spouse and dependents (without regard to their status as eligible individuals). However, distributions made for expenses reimbursed by another health plan are not excludable from gross income, whether or not the other health plan is an HDHP.