Paying medical claims with a Health Savings Account. When can it be done tax free?

I have run into this situation several times recently: An employee attempts to pay for their qualified medical expense claim with their health savings account (HSA) tax-free dollars, but are still taxed or face penalties. Why would this happen? Well, the ability to pay with tax-free HSA dollars is not based on when an employee enrolls in the Qualified High Deductible Plan (QHDHP), but rather when he or she establishes the HSA. Yes, the HSA is established separately from the QHDHP. An employee may decide to establish their HSA immediately, after a few months, or may not establish one at all, even when they are enrolled in a QHDHP.

It’s important to establish the HSA when first enrolled in a QHDHP, even if the employee can only contribute the minimum amount. The contribution can be increased or decreased going forward. The date the HSA is established determines eligibility to “go back” to pay a claim.

Consider this example:

An employee, Don, decides to enroll his family in the QHDHP offered by his employer as of January 1. However, Don does not establish his HSA until February 1. He incurs a $10,000 claim on January 12th with follow up doctor visits on January 16th, 23rd and 30th. On the February 15th payroll, Don adds $5,000 to his HSA to help pay the claims from January. Here’s the timeline:

  • January 1 –  Don enrolls in QHDHP
  • January 12 –  Don incurs $10,000 claim with follow up doctor visits on January 16th, 23rd, and 30th
  • February 1 – Don establishes his HSA
  • February 15 – Don adds $5,000 to his HSA to help pay for January claims

Don’s QHDHP has a $3,000/$6,000 embedded deductible. Don thought he would pay for his January claims when they came due in February or March with his HSA funds, and still have money left over after he’d met the $3,000 individual deductible portion.

However, his HSA account was not established until after the claims occurred. Though these claims would still apply to his deductible, Don cannot use his pre-tax HSA funds to pay for these claims. If he did, he would be subject to taxes and potential penalties.

Employees can fund their HSA to the applicable maximum established by the IRS each plan year, but they cannot pay for claims which occurred prior to the HSA being established.

To avoid this kind of problem, it’s important that employers educate their employees on the importance of opening their HSA at the same time as enrolling in the QHDHP being offered.

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About Randall Graham

Randy holds a bachelor’s degree from Southern Methodist University and holds Chartered Life Underwriter and Accredited Investment Advisor designations. He joined J.W.Terrill in 1979 as a Vice President of sales where he is responsible for providing and managing all aspects of sales, administrative services and consultative services for client accounts.

View all posts by Randall Graham

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