Recently, reader Brad F wrote to us with a dilemna:
"First of all, I enjoy your site [ed: /blushes].
I think other readers (and employees of your clients) may face the same issue I now face. Later this year, I am getting married. After the wedding, we planned to consolidate our health coverage with her employer. Unfortunately, my HR department just informed me I will face “tax consequences” if I leave my high-deductible plan for her PPO before the end of 2008. Although I can avoid the penalty by staying with my plan for a few extra months, it was a definite unexpected surprise."
In general, if one leaves an HSA/HDHP (Health Savings Account/High Deductible Health Plan) mid-year, one has a number of issues. From a coverage standpoint, there's a new deductible to satisfy. Although it's likely to be (much) lower than the High Deductible plan's, it does start at "$0 met" on the first day of coverage, previous HDHP-covered expenses notwithstanding.
From a tax standpoint, there are also some speedbumps:
1) You can't make any more contributions (dunh!)
2) You may well have overfunded the account. This is kinda screwy: if you start an HSA mid-year, the contributions aren't pro-rated (that is, you can still fund the max, if you want). But it doesn't work in reverse: you'll have to withdraw the excess contributions, and there are some taxes to be paid on those.
Curiously, you can still use the HSA to pay for qualified medical expenses. That is, even though the underlying plan isn't HSA-qualified, you can still use the account itself to pay for most medical expenses, with no tax or other penalties.
But I wasn't the only one who responded to Reader Brad. Co-blogger Mike Feehan offered a different perspective:
I don't see this as a now-or-never choice. (I)t appears to me that the basic amount at stake here is
(a) the difference (presumably a savings) between the payroll deduction in his own plan and the dependent deduction in his new wife's plan vs.
(b) the "tax consequence" (i.e., a cost) for dropping his employer's plan before year end.
So it boils down to the customary question: is the savings bigger than the cost?
First of all, I think the correspondent should ask his employer to tell him, in dollars and cents, exactly what the "tax consequence" will be to him in 2008. He can then judge whether it's better for him to disenroll before year-end and eat the tax consequence, or stay in his own plan until the end of the year and pay his own premium contribution for those few months.
No matter what, he [should] be able to enroll in his new wife's plan effective January 1, if he wants to, during the open enrollment period later this year.
What is the tax consequence anyway? I've understood that IRS allows certain tax advantages in group "cafeteria" plans - - subject to certain conditions, one of which is that there can be only one benefit election or open enrollment for any taxable year. To the insured person, the tax advantage is that premiums are paid or deducted from payroll on a pre-tax basis, which reduces one's taxable income. So from IRS' standpoint, you've agreed to a tax deal when you enroll in a cafeteria plan, and breaking the terms of the tax deal forfeits the tax benefit. You point out that the tax deal includes the employee's own contributions to the HSA (which also reduce one's taxable income) so those contributions would also become subject to tax if one were to drop out mid-year.
An employee who chooses not to enroll during the open enrollment, can enroll later but only under certain circumstances permitted by IRS. An employee who enrolls but then later decides to drop out can do that, too, but in that case the cost is forfeiture of the tax advantages for that taxable year. (The forfeitures don't apply to employees who "drop out" because of retirement, or termination of employment, or death.)
I may not have all the details 100% but I think this is pretty close.
PS - I certainly hope we are not getting to the point where our choice of wedding day is influenced by the tax treatment of our medical insurance premiums!
So there you have it! Thanks to Brad F for the great email, and to Mike for his help in answering it.
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