The Perfect Gift for that Young Adult Child? How about an HSA and a Contribution?

Why not give a gift that'll last a lifetime and delivers some important financial lessons to the recipient?

'Tis the season of gift-giving. As you look back on Christmases (or Hanukkahs or other holidays) past, how many presents do you really remember? How many were life-changing? As crazy as it sounds initially, a contribution to a young adult child's Health Savings Account can be such a gift. More than a gift - a legacy.

Not convinced? Let's review why it may make sense if your adult child is under age 26, covered on your HSA-qualified plan, is no longer your tax dependent, and meets other requirements to open and fund a Health Savings Account.

Reason No. 1: A Tax-Free Reimbursement Option

In most cases, your child can remain covered on your medical plan until the child turns age 26. If the child no longer qualifies as a tax dependent under Section 152 of the federal tax code, however, you cannot continue to reimburse that child's qualified expenses tax-free from your HSA. That's right - even if the child remains covered on your plan, tax-free distributions are limited to qualified expenses that you, your spouse, and your tax dependents incur.

Helping a child open and fund a Health Savings Account creates a source of tax-free funds to reimburse the child's qualified expenses. You or anyone else can fund the child's account. You may want to contribute some seed money or, to encourage the child to contribute as well, match the child's deposits. The child can fund her Health Savings Account up to the family limit, regardless of how much other family members fund theirs. Account owners receive the tax break for all contributions except those made by an employer, so the child - not you - can reduce her taxable income by the amount that you, she, and anyone else deposit.

[An important point: The rules for Health FSAs are different. You can reimburse qualified expenses that you, your spouse, your tax dependents, and your children to age 26 incur - even if they're not covered on your medical plan. If you also participate in your company's Limited-Purpose Health FSA, you can reimburse a non-dependent child's qualified dental and vision expenses from that arrangement.]

Reason No. 2: Good Financial Habits

A second reason to seed a child's Health Savings Account is to instill good financial habits, such as executing a savings plan early, putting money aside for known future expenses (analogies: auto repairs, travel, education), and leveraging tax-saving provisions in federal law. Building good financial habits isn't intuitive, and few schools teach this important concept. Walking a child through the steps to open a Health Savings Account and then providing some initial funds can spark a lifetime of wealth-building habits.

Reason No. 3: Open the Door to Lifetime Tax-free Reimbursement

Here's a strategy that few people understand. If you can grasp this and provide this gift to your child, you're providing an invaluable service that may be more important than leaving the child a financial bequest or a favorite car or fishing rod.

Step 1. Help your child open and fund a Health Savings Account. Once the account is established, the child can reimburse tax-free all qualified expenses for the rest of her life. For example, if she opens a Health Savings Account and you provide any level of seed money ($10 $250, $1,000 - the figure doesn't matter), the account is established. Once the account is established, all future qualified expenses can be reimbursed tax-free.

Step 2. Impress on the child that she must maintain a balance - even a small amount - at all times. Of course, she can contribute only when she's HSA-eligible, so it's important to find an account with no monthly administrative fee that can drain balances to zero and blow up the strategy.

Imagine this scenario: She opens and funds her Health Savings Account. When she ages off your plan, she enrolls in an employer-sponsored non-HSA-qualified plan because she isn't offered an HSA-qualified plan. She retains a balance in her Health Savings Account, though. She doesn't remember why, exactly - just that you told her it was important to keep a positive balance.

She dutifully participates in her company's general Health FSA to reimburse her qualified medical, dental, and vision expenses. Most years her Health FSA election is more than enough to cover her bills. But during a few years - when she gives birth to your grandchildren, her child is hospitalized following a bicycle accident, and her spouse tears an ACL playing soccer - her family incurs more bills for qualified expenses than she has funds in her Health FSA. Let's say $15,000 more over 10 years.

In mid-career, her employer sponsors an HSA-qualified plan. She enrolls, opens a new Health Savings Account, and begins contributing regularly, maybe up to the statutory maximum of, say, $12,000 at that point, or perhaps a lower figure. The amount doesn't matter.

Now, she can go back and reimburse those $15,000 of qualified expenses with her new contribution to her new Health Savings Account. Why? Because she experienced a gap of no more than 18 months since she established her first Health Savings Account, she retains that original Health Savings Account's establishment date (rather than starting anew with the new account). Thus, she can now experience tax savings on those $15,000 of qualified expenses - a tax savings of more than $5,000 when considering federal payroll, federal income, and state income taxes - by funding her Health Savings Account and reimbursing those old expenses.

She may not have enough discretionary income to fund her account to the new statutory limit of $12,000 annually. She may be funding the account at $6,000 annually to reimburse her new qualified expenses. Good news: She doesn't have to be wealthy or have extra discretional income to execute this strategy.

Here's what she does:

1. She contributes $12,000 in equal payroll deductions ($500 per semi-monthly pay period). The $12,000 is more than she can afford, but read on.
2. Each month, she withdraws $500 and puts that money back into the family checking account to pay current bills. After a year, she has contributed $12,000 - enough to pay her $6,000 of current qualified expenses and an additional $6,000 to reimburse some of the old $15,000 of expenses.
3. By recycling the second $6,000 of contributions right back into her checking account - perhaps monthly to maintain cash flow - to pay household bills, she reduces her taxable income dollar-for-dollar.
4. She repeats the process in future years until she has reimbursed the older qualified expenses that she didn't reimburse from other sources years earlier.

Think of it as legal money laundering if that visual makes sense to you. She takes a portion of her income, "launders" it (perfectly legally) through a tax-advantaged account, then spends the money on household expenses and receives the tax deduction. It's all perfectly legal if she retained the receipts to match against her current withdrawals for amounts higher than her current qualified expenses.

The Bottom Line

Most schools don't teach good financial habits, leaving young adults with little guidance on how to establish budgets, when to use debt, how and how much to save, and which accounts deliver tax savings. But you as a parent can. And if your child meets the requirements to participate in this type of tax-reduction strategy, she'll value your guidance and your seed money more than you can imagine.

#Benegames #HealthSavingsAccount #HSA #TaxPerfect #ICHRAinsights #ICHRA #WilliamGStuart #HSAguru #HealthSavingsAcademy

HSA Wednesday Wisdom is published every other week, alternating with HSA Question of the Week. The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.