Multiplying the Triple-Tax Benefits of a Health Savings Account With Adult Children Under Age 26

by: Jeff M. Brandon, Senior Wealth Planner

December 13, 2022

If you are currently employed with medical benefits, you may have had the opportunity to enroll in a high-deductible health plan with a Health Savings Account (HSA). Those that feel a high-deductible health plan with an HSA is right for their household can take advantage of the triple-tax savings not offered with other health plans. The triple-tax savings include above-the-line tax deductions for HSA contributions, taxed deferred growth and tax-free withdrawals for qualified healthcare expenses. However, there is another twist that many participants aren’t aware of. Adult children under 26 years old who are on their parent’s health insurance, but are not dependents on their tax returns, can ALSO contribute to their own HSA, multiplying the tax benefits.

HSAs were created as part of the Affordable Care Act (ACA) in 2014. For households who could bear the cost of a high-deductible health plan, the ACA created HSAs, which provide tax advantages when the accounts are funded, grown, and later withdrawn. High-deductible health plans typically have lower premiums than the traditional HMO, PPO and POS plans offered by employers, but as a trade-off, the employee must meet a higher deductible before copays, coinsurance and prescription benefits begin. Like other traditional health insurance plans, high-deductible health plans also have out-of-pocket maximums to protect against catastrophic health events. Many employers offer to fund a set amount to the employee’s HSA each year to jump-start the account to pay qualified medical expenses. Annual contribution limits to an HSA in 2023 are limited to $7,750 for family plans and $3,850 for individuals. This limit is a combination of employer and employee contributions for the year. Employee contributions can be added through payroll deduction or direct transfer to the institution managing the HSA. Any unused balances remaining in the HSA at year-end can be used in future years.

The triple-tax benefits of an HSA are unique tax benefits found nowhere else. First, employee contributions to the HSA are tax-deductible, meaning any money added to the HSA will not be counted towards their annual income. Second, HSAs can be held in a savings account or invested for future medical expenses. All the growth that occurs from year to year will not be taxed, much like an IRA. Third, withdrawals from the HSA are also tax-free when used for qualified medical expenses (co-pays, prescriptions, etc.). After age 65, when Medicare begins, HSA owners can no longer contribute to the HSA. However, HSA owners can also withdraw for non-qualified medical expenses penalty-free, but only pay ordinary income tax on the withdrawal.

One overlooked benefit of high-deductible health plans with HSAs is that adult children under age 26, who are still on their parent’s health insurance and are no longer claimed as dependents on their parent’s tax returns, can open their own single HSA with a separate contribution limit of $3,850 per year. This opportunity means an adult child can fund an HSA in their early twenties and have their own tax deductions now, along with 40 years of tax-free growth. If the child is still early in their career and may not have the $3,850 to contribute to their own HSA. Parents, grandparents, or anyone else can use part of their annual gift tax exclusion to provide the funds for the child to add to their HSA.

There are several things to consider before deciding to use a high-deductible health plan with an HSA to maximize tax benefits:

  • Can your monthly cash flow bear the burden of the up-front medical costs that must be paid out of pocket for medical and prescription costs before the high deductible is met?
  • Will you be able to make regular contributions to your HSA in anticipation of medical expenses?
  • Do you or family members on your plan have a chronic medical condition or expenses that will result in you using up most of your HSA contributions each year?
  • Will you or your child be able to fund the child’s HSA account while they are still on your plan?
  • Is your adult child NOT going to be claimed as a dependent on your tax return?

Regardless if you have an adult child who could take advantage of opening their own HSA or not, the tax advantage of a family HSA can be tremendous. If you have questions about HSAs or any other financial planning questions, please reach out to our Wealth Planners Jeff Brandon here or Michael Mueller here.

Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.