If Your Plan Started After Jan. 1, Don't Overlook This Savvy Contribution Tip!

Contributions to a Health Savings Account are always tracked on the calendar year. If you became eligible after Jan. 1, don't think that you must prorate your contribution limit. You may have an attractive alternative.

As 2022 winds down, it's time to think about how much you want to contribute to your Health Savings Account, given your preference for reducing taxable income, building your medical savings account, and balancing your other financial priorities. The good news is that if you became HSA-eligible after Jan. 1 this year, you have options.

You have time to ponder your strategy. But to maximize your tax savings, you need to consider promptly whether you want to increase your contributions through your company's Cafeteria Plan before the end of 2022. The window to do so is rapidly closing.

The Original Standard

When Health Savings Accounts launched in 2004, the contribution ceiling was quite rigid. The maximum that any owner could deposit was the lesser of the medical-plan deductible or the statutory contribution limit. Also, anyone who became HSA-eligible after Jan. 1 was required to prorate her contribution. As a result, account owners who were covered all year and satisfied their deductible couldn't set aside additional money to reimburse dental or vision expenses. And owners who became eligible to contribute during the year couldn't deposit enough to cover their medical deductible (which typically isn't pro-rated by the insurer for mid-year enrollment).

New HOPE Emerges

The Health Opportunity Patient Empowerment Act of 2007, which went into effect at the beginning of 2008, made two major changes to contributions. First, it lifted the "either/or" provision so that owners can now fund their accounts to the statutory maximum annual contribution, regardless of their medical-plan deductible. And it included the Last-Month Rule, which allows owners who become HSA-eligible after Jan 1 but no later than Dec. 1 the option to contribute up to the statutory maximum that calendar year. If the owner chooses to contribute more than the prorated maximum for this partial year of eligibility, she must remain HSA-eligible through the end of the following calendar year or pay taxes and penalties on the amount contributed above the prorated figure.

Example: Nestor enrolls in his new employer's HSA-qualified plan effective April 1, 2023, and is HSA-eligible as of that date. He is under age 55 and has self-only coverage. His prorated maximum for 2023 is $2,887.50 (nine months of eligibility with a statutory maximum contribution of $3,850). But he can deposit up to $3,850 and face no taxes or penalties on the additional $962.50 (the amount above the prorated maximum) if he remains HSA-eligible through the end of 2024.

To Prorate or Not to Prorate

When does it make sense to prorate? That's a personal decision. Here are some factors to consider:

Do I want to maximize my tax savings? If so, the Last-Month Rule provides the opportunity to contribute more.

Do I want to build my balance faster? Again, if so, the Last-Month Rule allows higher contributions.

Am I comfortable with the likelihood that I'll remain HSA-eligible through the end of the following calendar year? This consideration factors in your likelihood of remaining in the same job with the same coverage (consider your and the company's prospects) and whether you'll like this form of medical coverage.

Am I approaching age 65? When you enroll in any Part of Medicare, you're no longer eligible to fund a Health Savings Account. If you collect Social Security benefits on or after the month that you turn age 65, you're automatically enrolled in Medicare Part A and thus disqualified from further contributions. If you turn age 65 and are working for a company with fewer than 20 employees, you may be required to enroll in Part A and Part B as a condition of remaining on the company plan.

Make Your Move Now

If you're in the position to leverage the Last-Month Rule and want to contribute more, you have until April 17, 2023, to make your contribution. But you enjoy maximum tax benefits if you act today. Here's why:

When you contribute through your company's Cafeteria Plan, your money is deducted before federal income and payroll (FICA) taxes and state income taxes (except in California and New Jersey) are applied. You enjoy the tax benefit up front and receive all deductions to which you're entitled. To do so, you must adjust your payroll deductions for December promptly, before your company's cut-off date.

If you want to complete your funding in early 2023, you can contribute personal funds and deduct that amount on your personal income tax return (even if you take the standard deduction rather than itemize). You'll receive a credit for the federal and state (in all but the two states listed above) income taxes. But you won't recapture your payroll taxes. For most employees, payroll taxes reduce the tax savings by 7.65%.

The Bottom Line

Take time today (okay, perhaps this weekend) to finalize your 2022 contribution strategy and take the action necessary to fulfill that objective. Yes, you can procrastinate, but you'll lose some of the tax benefits if you don't make your contribution adjustment in time for the December payroll deductions through your company's Cafeteria Plan.

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