Health Savings Accounts and Veterans: Thank You for Your Service, but . . .

Health Savings Accounts and veterans who take advantage of government medical coverage and care may lose tax benefits.

The nation owes a great debt to Americans who choose to serve in the armed forces, whether they make it their life's work or an early-career commitment. Now everyone is willing to commit to deployment anywhere in the world in peacetime or during hostilities. It's unfortunate that those who make the commitment and utilize the benefits to which their military service entitles them face some roadblocks when it comes to opening and funding a Health Savings Account.

Let's look at two issues at the intersection of Health Savings Accounts and veterans' medical benefits.

 TRICARE

TRICARE is the medical coverage offered to active military personnel and their families. Many veterans who are eligible to do so retain this coverage when they transition to civilian life. Even when they enroll in coverage through their own or a spouse's civilian employer, TRICARE may provide some benefits as secondary insurance (for example, reimbursing a portion of high deductibles). And it's a great alternative to COBRA continuation or nongroup coverage when a veteran doesn't have access to employer-sponsored coverage - such as during a period of unemployment or between early retirement and Medicare eligibility.

Unfortunately, TRICARE doesn't offer an HSA-qualified option. Therefore, veterans who retain this coverage as back-up insurance can't open a Health Savings Account. That's true even if their company offers only an HSA-qualified plan and they meet all other eligibility requirements. And they can't make pre-tax or tax-deductible contributions, nor can they accept employer contributions that the company makes available to all employees who meet eligibility requirements.

They can open and fund a Health Savings Account only if they disenroll from TRICARE. Even if they never receive benefits from their TRICARE coverage, merely retaining it is disqualifying.

Veterans Health Administration

Most military veterans are eligible for care through the Veterans Health Administration (often referred to as VA care), a nationwide system of government-funded hospitals, clinics, and other medical facilities. The system is not without controversy - recall the issues a decade ago with scheduling visits at some facilities - but it generally provides quality care. And it has spurred innovation in the medical-delivery system because it treats many patients through decades, unlike many delivery systems who see patients come and go as their commercial coverage changes.

Patients who access care through the VA aren't permanently barred from opening or funding a Health Savings Account. But they can't make contributions for three months following treatment that's not preventive or connected to an injury or illness suffered during active duty.

Example: Hadley, a Gulf War veteran, is enrolled in her company's HSA-qualified medical coverage and funds a Health Savings Account. She visited her local VA facility in March 2022 to have her gall bladder removed. This service is neither preventive nor tied to a service-connected condition. Therefore, she can't contribute to her Health Savings Account for April, May, and June.

Decisions, Decisions

The intersection of Health Savings Accounts and VA care provides veterans with choices. In the example above, Hadley may have chosen to have her surgery at a VA facility to avoid the $3,000 self-only deductible on her HSA-qualified medical plan. To her, it may be worth sacrificing $912.50 (the $3,650 maximum contribution divided by 12 and multiplied by three months) to avoid a $3,000 for the facility charge, surgeon fee, anesthesiologist services, and other miscellaneous charges that would apply to her commercial plan's deductible.

This is a key point: It's prudent to consider not only the tax savings, but also out-of-pocket financial responsibility when determining whether to access VA care and lose eligibility to fund a Health Savings Account for three months or forego VA care and continue contributing. The tax savings on $912.50 at a 30% tax rate are $274.

The Better of Both Worlds

But it gets better! Hadley and her fellow veterans can receive VA care without sacrificing any Health Savings Account benefits if they schedule VA services optimally. They can do so by leveraging the Last-Month Rule, a provision in the federal tax code that says that anyone who's eligible to open and fund a Health Savings Account on Dec. 1 can contribute up to the full amount for that calendar year. The rule comes with an important caveat: She must remain HSA-eligible through the end of the following calendar year. If she fails to remain HSA-eligible during this testing period, she must withdraw contributions above the prorated maximum, include that amount in her taxable income, and pay a 10% additional tax as a penalty for overfunding the account.

Example 1: Hadley leverages the Last-Month Rule and funds her Health Savings Account to the $3,650 maximum in 2022. She remains HSA-eligible through the end of 2023. She faces no penalties.

Example 2: Hadley leverage the Last-Month Rule and funds her account to the statutory limit, then loses her eligibility in July 2023 when she changes jobs and enrolls in her new company's non-HSA-qualified plan. She must remove $912.50 from her account and include that amount in her 2023 taxable income. She must pay a penalty of $91.25 (10% of $912.50) additional tax.

The key to using the Last-Month Rule to increase contributions to the statutory limit is the timing of VA services. Since VA patients lose eligibility for three months if their care isn't preventive or service-related, they must complete their treatment by August. That way, they're ineligible to contribute for September, October, and November, but they become eligible again as of Dec. 1. If they complete their care at any point after Aug. 31, they won't regain eligibility before Dec. 1 and therefore can't apply the Last-Month Rule to increase their contributions beyond the prorated amount.

The Bottom Line

Unless and until Congress changes statute (several bills have been or will be introduced to address this issue) to accommodate veterans who want to (1) maintain or use the benefits to which their service entitles them and (2) fund a Health Savings Account, this intersection will be problematic. But with careful timing of VA care, veterans can still fund their accounts to the statutory limit.

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