How Does the HSA Testing Period Work?

The HSA testing period applies if you enroll in an HDHP mid-year

The HSA testing period is a way for the IRS to make sure that people aren't contributing more than the allowed amount to their health savings accounts (HSA). It only applies if you become eligible to contribute to an HSA mid-year but want to contribute the full year's amount to your HSA.

The IRS does allow that. But then you'll be subject to the testing period. If you don't keep your HSA-eligibility for the entire following year, you'll have to pay income tax on some of the money you contributed, plus an additional 10 percent surcharge.

HSA Contributions

If you've got coverage under an HSA-qualified high deductible health plan (HDHP), you can contribute pre-tax money to a health savings account (HSA) as long as you meet a few other basic conditions (i.e., you can't be covered by Medicare or any other health insurance plan except for some types of supplemental coverage, and you can't be claimed as a dependent on someone else's tax return). A person who meets these conditions is called "HSA-eligible" and is allowed to contribute to an HSA.

Contributing to an HSA is beneficial for multiple reasons:

  • It lowers your taxable income in the year you make the contribution.
  • The money in your account grows tax-free, including investment gains if you choose to invest it.
  • You can pull money out of your HSA at any time to pay qualified medical expenses, and those withdrawals are tax-free.
  • After you turn 65, you can withdraw money from your HSA for non-medical expenses, and you just pay regular income tax the way you would with a Traditional IRA. Alternatively, you can leave the money in your HSA and only withdraw it when you have medical expenses; it will continue to be fully tax-free if you take that approach.

Clearly, the more you can contribute to your HSA, the better. But to prevent HSAs from being merely a tax shelter for wealthy Americans, the IRS limits how much you can contribute to your HSA. The maximum contribution is adjusted annually and depends on whether your HDHP covers just yourself, or yourself plus at least one other family member.

In 2018, the maximum amount you can contribute is $3,450 if you have self-only HDHP coverage, and $6,900 if your HDHP covers at least one other family member. You can make monthly contributions or deposit the full amount all at once—and you have until the tax filing deadline (around April 15 of the following year) to make the contributions for a given year.

Enrolling Mid-Year in an HDHP

The first requirement for being able to contribute to an HSA is that you must have HDHP coverage. That's straightforward enough if you're covered for the full year. But what if you enroll in an HDHP in September? 

The IRS gives you two choices: You can either prorate the HSA contribution limit based on how many months you actually had HDHP coverage during the year. Or, as long as you're enrolled in the HDHP as of December 1, you can contribute the full amount allowed for that year. The latter choice will allow you to contribute more, which is beneficial in terms of lowering your tax bill that year and growing your stash of savings that can be used tax-free to pay future medical bills. But there's a catch—the testing period.

If you enroll in an HDHP mid-year and opt to contribute the full annual amount to your HSA, you then have to continue to be HSA-eligible throughout the testing period, which continues for the entire following year (you don't have to actually contribute to your HSA during the testing period; you just have to remain eligible to contribute to your HSA). You can switch from one HDHP to another during the testing period, but you can't switch to a non-HDHP insurance option or drop your coverage altogether, and you can't enroll in Medicare or another health insurance plan in addition to your HDHP coverage.

If You Fail the Test

If you don't remain HSA-eligible for the entire testing period, you're going to owe the IRS some money.

Failing to remain HSA-eligible could happen because you switch to a non-HDHP (maybe because your employer changes health plans, which is always a possibility), or because you turn 65 and enroll in Medicare.

Whatever the reason, if you don't remain HSA-eligible for the entire following year, the IRS is going to go back and see how much you contributed to your HSA in the year that you became HSA-eligible mid-year.

They'll calculate how that amount compares with the prorated amount that you would have been allowed to contribute based on the number of months that you were HSA-eligible, and you'll owe income tax plus an additional 10 percent tax on the difference.

An Example

Let's say you enroll your family in an HDHP in August 2018, and you're still HSA-eligible as of December 1, 2018. If you choose the prorated HSA contribution limit, it would be five-twelfths of the annual limit. That amounts to $2,875 (calculated by dividing 6,900 by 12, and then multiplying the answer by 5). If you contribute that amount (or less) to your HSA for 2018, your health coverage and HSA eligibility in 2019 won't be an issue.

But if you're confident that you're going to remain HSA-eligible throughout 2019, you could contribute up to $6,900 to your HSA for 2018, despite the fact that you were only HSA-eligible for five months of the year.

Assuming you do remain HSA-eligible throughout 2019, all is well: You were able to contribute the full annual amount in 2018, and can do so again in 2019 if you choose to do so.

But let's say you switch to a new job in July 2019, and your new employer doesn't offer an HSA-qualified plan. You could decline your employer's coverage and buy an HDHP in the individual market, but that's probably going to end up being more expensive than just taking your lumps with the testing period, since you'd be giving up the employer subsidy and tax benefits that go along with employer-sponsored health insurance. So in reality, you're probably going to end up switching to your new employer's plan and losing your HSA-eligibility before the end of 2019.

In that case, the IRS will look at the $6,900 you contributed to your HSA in 2018, and subtract the $2,875 that you would have been eligible to contribute based on the actual number of months you were HSA-eligible in 2018. The difference ($4,025) will be added to your taxable income in 2019. And you'll also owe an additional 10 percent tax on that $4,025, which will amount to about another $400 added to your tax bill for 2019. 

Contributing the Full Amount

There's no one-size-fits-all answer to whether you should contribute the full annual amount to your HSA if you become HSA-eligible mid-year. Contributing the full amount will give you tax benefits for the current year, but you'll have to pay back the tax savings—plus the additional 10 percent tax—if you don't end up staying HSA-eligible for the entire following year.

There are some scenarios in which it definitely makes sense to go with the prorated contribution limit instead, such as knowing that you're going to enroll in Medicare or switching to a non-HDHP in the coming year.

But if you anticipate remaining HSA-eligible for the entire coming year, you can opt to take advantage of the fact that the IRS will let you contribute up to the full annual contribution limit to your HSA, even if you become HSA-eligible on December 1.

The later in the year it is when you become HSA-eligible, the more it will benefit you to go with the full contribution limit rather than the prorated amount. But that will also mean that the additional taxes you'll owe if you stop being HSA-eligible during the testing period will be more significant. As the rewards increase, so do the risks!

If you enroll in an HDHP mid-year, you'll want to carefully consider whether you'd be better off using the prorated contribution limit for your HSA, or contributing the full year amount and becoming subject to the testing period. 

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