Spring 2018: Don’t Forget About the Health Savings Account

By Jordana S. Kershner, Esq.

With health care prevalent in the news lately, and the rising cost of health care a common topic within that conversation, it is important that as family law practitioners we are familiar with the resources available to families to pay for health-related expenses and how they are relevant in divorce cases.  This article will provide an introduction to the different tax-favored health plans (“TFHPs”), how to identify them during a divorce, and ways to approach their treatment as part of settlement.

Tax-Favored Health Plans

There are primarily four types of TFHPs: (1) Health Savings Accounts (“HSAs”); (2) Medical Savings Accounts (“MSAs”); (3) Health Flexible Spending Arrangements (“FSAs”); and (4) Health Reimbursement Arrangements (“HRAs”).  Each type of TFHP has different tax advantages, and rules regarding contributions, distributions, qualifying persons, etc.  This article is meant to briefly identify the most significant and basic features of each.  For a more thorough resource regarding the different types of TFHPs, consult IRS Publication 969, which is updated and published by the IRS each year.  This year’s publication can be found at: www.irs.gov/pub/irs-pdf/p969.pdf.  

All of the information regarding the four types of HSAs in this Section II is drawn from IRS Publication 969, Cat. No. 24216S, March 1, 2018.

HSAs: An HSA is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. Additional key features include: 

  • HSAs may receive contributions from an eligible individual or any other person, including an employer or a family member on behalf of an eligible individual.
  • Contributions are deductible on the eligible individual’s return.
  • Employer contributions are not included in gross income.
  • Distributions to pay qualified medical expenses are tax free.  The expense does not have to be for you, it can also be for your spouse, dependents that you claim, and, in some circumstances, dependents that you could have (but did not) claim on your tax return.
  • The contributions remain in your account until you use them.
  • The interest or other earnings on the assets in the account are tax free.
  • HSAs are “portable” if you change employers or leave the work force.
  • To qualify for an HSA, you must:
    • Be covered under a high deductible health plan (“HDHP”), as defined by IRS regulations;
    • Have no other health coverage except as permitted by IRS regulations;
    • Not be enrolled in Medicare; and 
    • Not be claimed as a dependent on someone else’s tax return.
  • The amount that can be contributed to an HSA annually depends on the type of high deductible coverage you have, your age, the date you become an eligible individual, and the date you cease to become an eligible individual.
  • Distributions:
    • When you pay medical expenses during the year that are not reimbursed by your plan, you can ask the trustee of your HAS to send you a distribution.
    • If you receive distributions other than for qualifying medical expenses, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax.
    • You do not have to make distributions each year.

2.  MSAs: Most MSAs are considered “Archer” MSAs.  An Archer MSA is a tax-exempt trust or custodial account that you set up with a U.S. financial institution in which you can save money exclusively for future medical expenses.  They were created to help self-employed individuals and employees of certain small employers.  There are also Medicare Advantage MSAs, which are Archer MSAs designated by Medicare to be used solely to pay the qualified medical expenses of the account holder who is eligible for Medicare.  Additional key features of MSAs include:

  • Contributions are deductible on the eligible individual’s return.
  • Distributions to pay qualified medical expenses are tax free.  The expense does not have to be for you, it can also be for your spouse, dependents that you claim, and, in some circumstances, dependents that you could have (but did not) claim on your tax return.
  • The contributions remain in your account until you use them.
  • The interest or other earnings on the assets in the account are tax free.
  • MSAs are “portable” if you change employers or leave the work force.
  • To qualify, you must be either:
    • An employee (or the spouse of an employee) of a small employer, as defined by IRS regulations, that maintains a self-only or family HDHP for you (or your spouse); or
    • A self-employed person (or the spouse of a self-employed person) who maintains a self-only or family HDHP.
    • You cannot have other health coverage except as permitted by IRS regulations.
  • Contributions are limited as follows:
    • Cannot exceed 75% of the annual deductible of your HDHP (or 65% if you have a self-only plan); and
    • Cannot exceed more than you earned for the year from the employer through whom you have your HDHP.
  • Distributions:
    • When you pay medical expenses during the year that are not reimbursed by your plan, you can ask the trustee of your HAS to send you a distribution.
    • If you receive distributions other than for qualifying medical expenses, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax.
    • You do not have to make distributions each year.

3.  FSAs: Allows employees to be reimbursed for medical expenses.  Additional key features include: 

  • You contribute to your FSA by electing, at the beginning of the plan year, an amount to be voluntarily withheld from your pay by your employer.  Your employer may also contribute, if specified in the plan.
  • Contributions made by your employer can be excluded from your gross income and no employment or federal income taxes are deducted from the contributions.
  • Distributions to pay qualified medical expenses are tax free.  The expense does not have to be for you, it can also be for your spouse, dependents that you claim, and, in some circumstances, dependents that you could have (but did not) claim on your tax return.
  • You can withdraw funds to pay for qualified medical expenses even if you haven’t yet placed the funds in the account.
  • For 2017, salary reduction contributions cannot be more than $2,600 per year (and can be lower if set by the plan).
  • Generally, contributions that aren’t spent by the end of the year are forfeited, although there are exceptions. They are “use-it-or-lose-it” plans.
  • You must provide the FSA with a written statement from an independent third party stating that the medical expense has been incurred and the amount of the expense.  Advance reimbursements are not permitted.
  • Debit cards, credit cards, and stored value cards given to you by your employer can be used to reimburse participants, and, if the use of the cards meet certain substantiation methods, you may not have to provide additional information to the FSA.

4.  HRAs: Key features include that HRAs: 

  • HRAs must be funded solely by an employer. There is no limit on the amount your employer can contribute.
  • Contributions made by your employer can be excluded from your gross income and no employment or federal income taxes are deducted from the contributions
  • Distributions to pay qualified medical expenses are tax free.  The expense does not have to be for you, it can also be for your spouse, dependents that you claim, and, in some circumstances, dependents that you could have (but did not) claim on your tax return.
  • Any unused amounts can be carried forward for later years, but these amounts may never be used for anything but reimbursements for qualified medical expenses.
  • HRAs may be offered in conjunction with other employer-provided health benefits. Self-employed persons are not eligible.
  • Generally, distributions must be paid to reimburse you for qualified medical expenses you have incurred.  Debit cards, credit cards, and stored value cards given to you by your employer can be used to reimburse participants and, if the use of these cards meets certain substantiation methods, you may not have to provide additional information to the HRA.

What is a qualified medical expense is an important determination for each type of TFHP.  Generally speaking, they are expenses that would qualify for the medical and dental expenses deduction.  There is a separate IRS publication, Pub. 502, that further details those deductions.  Non-prescription medicines, other than insulin, are not qualified.  A medicine or drug will be qualified if it requires a prescription, or, if it does not require a prescription you still get a prescription for it, and insulin. 

Identifying Tax-Favored Health Plans in a Divorce

Ideally, a spouse with a TFHP will disclose it on his or her Rule 401 financial statement and provide statements in his or her Rule 410 production.  It is not uncommon, however, for people to forget (and I use that word generously) to include these assets, even though they clearly are assets that should be included therein.  Failure to identify the existence of a TFHP account, and therefore failure to provide for it as part of a settlement or trial preparation, would likely be a windfall to the account-owner at the expense of your client.  When preparing your client’s Rule 401 financial statement and gathering his or her Rule 410 documents, be sure to ask about these assets so that you can properly disclose them.  Also ask your client whether his or her spouse has such an asset so that if it is not included on the disclosures, you can inquire with opposing counsel; spouses usually, but do not always, know whether his or her spouse has a TFHP account.  When you receive a Rule 410 production, review the party’s paystubs because the deductions can often be a tip off if there is a TFHP benefit being deducted from pay.  If you are doing more formal discovery, you should certainly include a question in any Interrogatory and/or Request for Production of Documents designed to identify and determine the type, value, and benefits of a TFHP.  

How to Treat Tax-Favored Health Plans in a Divorce

There are three approaches I have employed when negotiating an agreement with regard to TFHPs.  The first is for the spouse whose TFHP it is to retain it with the value offset against another asset.  The asset against which it is offset should be a post-tax asset because of the tax status and benefits of TFHPs.  If the only other post-tax asset in the marital estate is a Roth IRA, the parties may feel comfortable offsetting against that, but they may not feel it is truly “apples to apples” because of the age requirements for penalty-free withdrawal from IRAs.  If that is the case, or there are no post-tax assets against which to offset, the second approach is to tax-effect the TFHP before offsetting it, although this requires reaching an agreement about the appropriate rate at which to apply the tax-effect.  

A less common approach, but one that avoids the potential pitfalls of the first two, is to value the TFHP at the time of divorce and set it aside to be used by the parties post-divorce.  For example, if Father has a TFHP with a balance of $5,000 as of the date of the Judgment of Divorce, the separation could provide that the first $5,000 of the child(ren)’s qualifying health expenses will be distributed from the TFHP and it is not until that amount is exhausted that whatever provision for sharing of such expenses between the parents goes into effect.  If you choose this option, be sure to include language that future contributions to the TFHP are the sole property of the contributing spouse, and that the spouse who has title to the TFHP may not utilize the TFHP for his/her own qualifying expenses (to ensure that the full date of judgment balance is available to be used for the child/children.)

While this article focuses on approaches to TFHPs in settlement, if your case is proceeding to trial, be sure that you are familiar with and are able to present to the Court the tax status and consequences of all TFHPs in the marital estate. 

Jordana S. Kershner is a senior associate with Baskin & Associates, LLC, where she has been exclusively practicing domestic relations law since early 2012.  Ms. Kershner is a Co-Chair of the Communications Committee and member of the Steering Committee for the Family Law Section of the Boston Bar Association as well as a member of the Women’s Bar Association.  She is also a volunteer for the Probate and Family Court Lawyer for the Day program, Suffolk’s SERV program, and is a certified conciliator.