Newly Enrolled in an HSA-Qualified Plan? How Much Can You Deposit?

If you enrolled in HSA-qualified coverage and meet eligibility requirements, you can open and fund a Health Savings Account. But how much can you contribute?

Did you enroll in a Health Savings Account program for the first time when your company's medical coverage renewed July 1? Are you a new employee who chose this plan for the first time?

If so, and you meet all eligibility requirements, you have decisions to make about how much to fund your Health Savings Account in 2022. The good news is that you have options, which account owners prior to 2008 didn't have. The bad news is that you have options, which means that you may have to think about a funding strategy.

If you plan to contribute no more than half the statutory limit (see two paragraphs below), you don't need to decide, crunch numbers, or think about your personal situation. But you do have an option to deposit more into your Health Savings Account if your goal is to build your balance faster or maximize your tax savings - or both.

Tracking Contribution Limits

Contributions to Health Savings Accounts are always tracked on the calendar year. It doesn't matter whether your coverage starts July 1 or Dec. 15. It doesn't matter whether you become HSA-eligible Jan. 1 when your new coverage starts or April 1 because you carried a balance from your calendar-year general Health FSA into a grace period.

In 2022, your maximum contribution is $3,650 if you're enrolled in self-only coverage and $7,300 if you cover yourself and at least one other family member (even if only one of you is HSA-eligible). In 2023, those inflation-fueled numbers increase to $3,850 and $7,750. If you're age 55 or older at any point in either year, you can deposit an additional $1,000 through a provision known as the catch-up contribution.

These limits include deposits from all sources. If your company contributes to your Health Savings Account, that amount reduces dollar-for-dollar the amount that you can fund your account through pre-tax payroll deposits or tax-deductible contributions.

Prorating Contributions

The simple approach is to prorate your contribution based on the number of months that you're eligible to open and fund a Health Savings Account.

Example: You become HSA-eligible July 1, are under age 55, and enroll in family coverage. The maximum contribution. The statutory maximum annual contribution of $7,300. You can contribute up to 6/12 of that amount, or $3,650.

This option is easy to understand and implement. It includes no obligations beyond the calendar year (a concept that will become clear in a moment). But you don't build your balances as quickly nor enjoy tax benefits as great as you do when you take the other approach. And if you incur high expenses during this partial year, you may not have adequate balances to pay your bills as they are due. [Note: You can repay yourself with tax-free money from future years' contributions as well.]

Leveraging the Last-Month Rule

The alternative is to use what's called the Last-Month Rule. Under this approach, if you become eligible to open and fund a Health Savings Account after Jan. 1 but no later than Dec. 1 (the last month of the year), you can contribute up to the statutory limit that year. This rule allows people who meet eligibility requirements for as little as one month during the calendar year to deposit as much money in their accounts as owners who were eligible during all 12 months.

But there is an important follow-up responsibility. You must remain HSA-eligible through the end of the following calendar year, a span of time known as the testing period. If you don't, any contributions above your prorated maximum are included in your taxable income and you're assessed a 10% additional tax as a penalty.

Example: Same scenario as above. You can contribute the full $7,300 in 2022. If you lose eligibility before the end of the testing period, you must include $3,650 in taxable income and pay an additional $365 as a penalty.

The advantage of this approach is that you maximize your tax savings and account growth. But you're not in the clear until the end of the testing period. A lot can change in 13 or 18 or 23 months.

When evaluating this option, ignore the prospect of including $3,650 in taxable income if you fail to remain eligible through the testing period. If you prorate, you sacrifice those tax savings up front. The real "cost" to failing to remain eligible during the testing period is, in our example, the additional $365 tax that you pay as a penalty. For most taxpayers, a reduction in taxable income of $3,650 translates to about $1,000 in tax savings. Are you willing to put $365 at risk to receive a tax break of $1,000? Only you can answer that question.

Which Option Is Optimal?

So, which option should you choose? It depends. Here are some considerations:

Do I want to maximize my contributions and tax savings? If so, apply the Last-Month Rule to contribute more than your prorated maximum. You build your balance faster and reduce your taxable income with every dollar that you contribute.

Do I foresee my situation changing before the end of next year? In other words, are you thinking about leaving your job? Are your company's fortunes perilous? Are you contemplating retirement? If you have concrete reason to believe that you may not remain HSA-eligible through the testing period, you may want to opt for the safer prorating method.

Am I risk-averse? If you never want to put yourself in a position in which you may have to pay penalties, you may want to prorate. You sacrifice tax savings and account balances, but your reward is better nights' sleep.

The Bottom Line

As with any financial decision, you should understand your options. Only about 4% of Health Savings Account owners fund their accounts to the statutory limit in a typical year. And the average contribution has hovered between $1,5500 and $2,000 during the last decade. Thus, for most owners, the information above isn't relevant.

But why be average? Why not at least explore options to build wealth and minimize taxes? Health Savings Accounts offer those benefits with higher limits than Health FSAs and superior tax advantages to traditional retirement accounts. If your goal is to avoid tax friction, maximize savings, and build an emergency healthcare savings account, Health Savings Accounts are a forceful ally. And the Last-Month Rule provides you with an opportunity to turbocharge these benefits if it's appropriate in your situation.

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