Kid Graduating and Aging Off Your Plan? How Is Your HSA Affected?

College graduation season is upon us. If your child is covered on your medical plan, what are the implications for your Health Savings Account?

College graduation. The end of one largely scripted journey and the beginning of another without a tried-and-true map. This is an exciting time for many young adults. Among the last topics on the minds of most new graduates is medical coverage. Nearly all have been covered on a parent's plan since birth and couldn't define terms like pre-authorization, out-of-network deductibles, and usual, reasonable, and customary. But the clock is ticking on their needing to know these terms or suffer the consequences.

Of course, graduation isn't necessarily a triggering event, since children can remain on a parent's plan until age 26. I'm carrying an almost-25 -year-old son who graduated from college in 2019. I expect he'll remain on my plan for another 15 months until he turns age 26.

If you have a new college graduate in the family (the same principles below apply to high-school graduates as well) and are covered on an HSA-qualified medical plan, perhaps one of more of the scenarios below describes your situation.

Contributions: Child Remains on Your Plan

Prior to implementation of the Affordable Care Act of 2010, there was no uniform rule on when coverage ended. Often, children were not eligible to remain on a parent's plan past age 19, or past age 22 or 24 if the child remained a full-time student. The new federal rule is that children can remain on a parent's coverage until age 26. Today, it's not uncommon for children to remain covered on a parent's plan, even if the child is working full-time and is eligible for employer-sponsored benefits.

In this situation, nothing changes. You remain covered by a family plan and can contribute up to $7,300 in 2022.

Contributions: Child Disenrolls from Your Plan

Your child's disenrollment affects your contribution limit only if you drop in coverage tier from family to self-only. In that case, you must prorate your 2022 contribution.

If your child disenrolls from your plan as of, say, Aug. 31 to enroll in her new employer's plan and your coverage drops from family to self-only, you must pro-rate your 2022 contribution. Here's the calculation:

• You're covered by a family contract for eight months. Divide $7,300 by 12 ($608.33) and multiply that by eight months for a total of $4,866.66.
• Your coverage drops to self-only beginning Sept. 1. divide $3,650 by 12 ($304.16) and multiply by four months for a total of $1,216.66.
• Maximum contribution: $6,803.33.

If you're eligible to make a catch-up contribution, here's some good news: The $1,000 maximum applies regardless of contract size. Thus, you don't have to pro-rate this amount.

Distributions: Child Remains Your Tax Dependent

If you still provide more than half your child's support after she graduates from college, she most likely will continue to qualify as your tax dependent under Section 152 of the federal tax code. In that situation, you can continue to reimburse her qualified expenses tax-free from your Health Savings Account. You can do so whether or not she remains covered on your medical plan.

That's right - even if she's no longer (or never was) covered on your medical plan. That's because tax status, not coverage, determines whose expenses you can reimburse tax-free from your account. If she's your tax dependent, you can reimburse her qualified expenses tax-free from your Health Savings Account. Period.

Distributions: Child Is No Longer Your Tax Dependent

Conversely, if your child begins to support herself and no longer qualifies as your tax dependent, you can no longer reimburse her qualified expenses tax-free - even if she remains enrolled on your coverage. That's the other side of the coin described above: Again, tax status, not coverage, is the deciding factor.

Effects on the Child

Your child's tax-dependent status is important not only to you, but to her as well.

Child remains you tax dependent: She can't open and fund her own Health Savings Account. The only option to reimburse her qualified expenses tax-free is through your account. Again, per our conversation above, this is true whether or not she remains covered on your medical plan.

Child is no longer your tax dependent: If she remains enrolled in your medical coverage and meets other requirements to open a Health Savings Account, she can open and fund her own account. She can then reimburse her own qualified expenses tax-free.

If she's in that uncomfortable financial position of (1) no longer qualifying as your tax dependent and (2) not fully able to live completely independently from you, there's hope. You - or anyone else - can contribute to her Health Savings Account. She receives the tax deduction for contributions, regardless of who makes them. In most cases, because your marginal tax rate is higher than hers, a dollar contributed to her account generates lower tax savings than the same dollar deposited into your Health Savings Account. That's unfortunate, but funding her account is the only way that her qualified expenses can be reimbursed tax-free when she's no longer your tax dependent.

How much can she contribute to her account if she remains covered on your medical plan and you're actively funding your Health Savings Account? Let's see . . .

Multiple Family Members HSA-eligible

Let's assume that both you and your child remain covered on your medical plan, she's no longer your tax dependent, and both of you meet the eligibility requirements to fund your own Health Savings Accounts. How much can the two of you contribute to your respective Health Savings Accounts?

The $7,300 family limit split between the two of you?

No more than the self-only maximum ($2,650 in 2022) each?

Some other figure?

This is where it gets interesting. You can fund your account to the statutory limit of $7,300 because you're covered on a family plan. Plus, you can deposit up to another $1,000 if you're age 55 or older.

She can also contribute up to $7,300 to her new Health Savings Account as well. Why? Well, she's covered on a family plan. She's not married to you (spouses who each have opened an account are limited to $7,300 in total contributions, which they can allocate to each account as they choose.)

That's right. For the price of a single deductible, you and your child can each contribute up to $7,300 to your respective Health Savings Accounts.

Establishing an Account

Your daughter may not have $7,300 in discretionary income or assets that she can liquidate to fund her new Health Savings Account to the limit. But don't let that deter her from opening an account or your or her from depositing some amount of money into the account.

Here's why: Once you open and fund a Health Savings Account and maintain a balance, you can reimburse all future qualified expenses tax-free from that account. Let's see how this rule plays out:

Example: Your daughter remains covered on your medical plan and is no longer your tax dependent. She opens a Health Savings Account, and you give her $100 to deposit into the account. She retains that balance and saves her medical receipts. She subsequently enrolls on employer-sponsored coverage that isn't HSA-qualified. A dozen years later, she becomes HSA-eligible again and begins to fund her old account or a new one. She can use her new contributions to reimburse all qualified expenses that she incurred since the day that her initial Health Savings Account was funded, as long as (1) she maintained a balance - any balance, no matter how small - in the old account and (2) she retains the receipts in case the Internal Revenue Service audits her tax return.

Thus, acting now can save her potentially thousands of dollars down the road. If she accumulates, say, $10,000 in qualified expenses during the dozen intervening years, she can make future contributions pre-tax through her employer's Cafeteria Plan over several years and then immediately withdraw the funds to reimburse those old qualified expenses. She must (1) retain receipts to match against those withdrawals to preserve the pre-tax status of the distribution and (2) ensure that the expenses are qualified and were incurred after she established her Health Savings Account.

The Bottom Line

Once again, knowledge is power. If you understand how the Health Savings Account rules work, you can leverage them to secure a brighter financial future.

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