Life Changes and HSAs: Experiencing a Divorce
Big life changes can throw employees for a loop, and divorce can be one of the most difficult life changes to navigate. The process of untangling assets and finances can often be long and complicated. Employee benefits – like health savings accounts (HSAs) – are assets that need untangling in a divorce settlement.
This post offers helpful tips, so employees can understand how a divorce may impact their HSA.
How divorce can affect HSAs
Even though an HSA is an individual account and cannot be jointly shared with spouses, account balances are considered at the time of a divorce. Depending on the details of a court judgment, one person’s HSA funds may be divided between the spouses or given in part or full to the former spouse.
Did you know divorce is a qualifying event to make plan changes? If an employee is going through a divorce, make sure they know this life change makes them eligible to alter their HSA coverage at any point during the year, rather than waiting until open enrollment.
After a divorce, an employee might wish to switch their health care coverage and their HSA from an individual plan to a family plan, or vice versa, depending on the coverage they will need in their new situation.
Tip: To avoid additional taxes, the former spouse should consider transferring funds to an HSA in their name. If the money is put into another kind of account, the IRS will tax it as income.
Two methods used by the IRS
When making a plan change, employees should be aware of two methods the IRS uses to determine their new HSA annual contribution limit, based on whether the employee is changing from an individual plan to a family plan, or from a family plan to an Individual plan.
Method #1: If an employee switches from an individual plan to a family plan before Dec. 1 of the tax year, the IRS uses the 13-month or last month rule.
Under this rule, an employee can contribute the full family HSA limit for the year ($7,200 for 2021), even if they didn’t have a family plan for the entire calendar year. However, employees should know it will require them to keep that same family HSA coverage for 13 months – through Dec. 31 of the following tax year – to avoid tax penalties from the IRS.
Method #2: For a change from a family plan to an individual plan, the IRS uses proration, which calculates which specific months an employee had a family plan vs. an individual one.
For example, if during 2021, an employee spends the first six months of the year on a family plan and the last six months on an individual plan, they will have a combined maximum annual contribution limit of $5,400, significantly higher than the $3,600 individual limit.
A key HSA reimbursement rule
A key rule an employee should know post-divorce: While a married HSA holder can reimburse eligible medical expenses for themselves or their spouse tax-free, they cannot do so for an ex-spouse. This is true even if a divorce decree allows an ex-spouse to stay on an employee’s health care plan for a certain amount of time.
However, if the couple has children, the use of a family HSA plan is unaffected by divorce, even if only one parent now claims the child as a tax dependent. Either parent can generally use their contributions to pay for a child’s medical costs as long as the child is a tax dependent.
