Tax-Advantaged Health Insurance For Your Children

Woman looking over health insurance forms

Parents are aware that their child should never be in a "health insurance gap." As soon as a child no longer is covered by the family's insurance, his or her own insurance should be in place. When it comes to insurance coverage that includes a Health Savings Account (HSA), the changeover will depend on several factors.

Just a little background, here. HSAs were established in late 2003. Included within the much wider Medicare prescription drug legislation, the HSA program was a hat-tip to health-care-cost reduction. Its creation included the simultaneous enactment of a new Internal Revenue Code section to provide Americans with a tax-incentive for saving to cover their health care needs.

How it works

Here's how it works. A Health Savings Account must always be paired with a high-deductible health plan (HDHP); the two go together. (And many insurance companies offer them as a package.) If an individual or family has an HSA, their health insurance plan, which must be an HDHP, requires a higher than usual out-of-pocket payment each year before insurance coverage kicks in. Important: the tax-advantaged HSA may not be used to offset that deductible, but it does cover a whole array of expenses that insurance may not cover such as dental care, vision care, health club membership, and premiums on a long-term care insurance plan.

For an insurance plan to fall into the category of an HDHP, its minimum annual deductible in 2019 had to be $1,350 for individuals and $2,700 for families. You should be aware that these amounts can be changed annually, though usually not by much. Notice also that these are minimum required deductibles. Plans actually can come with much higher deductibles (up to $6,750 individual, $13,500 family). Why would anyone choose such a high deductible? Because premiums are correspondingly much lower. That can be attractive for people generally in good health and able to meet some health care costs out of pocket.

When deciding on the size of the deductible, however, realize that you cannot spend from your HSA to meet the out-of-pocket costs. What you can do, though, is spend from the HSA for a wide range of health care costs not covered by your insurance. HSAs also come with a limit on the amount you can contribute each year. Remember, the contribution is fully tax-deductible and what you don't spend one year can be rolled over to the next year. That means the amount in an HSA can keep growing. (Interest and capital gains generated by the HSA also are fully tax-deductible.) One benefit is that individuals or families can build up a substantial nest egg by the time they retire—a time, frequently, when medical and health care costs begin to increase.

For 2019, the contribution limit is $3,500 for an individual plan and $7,000 for a family plan. In many instances, employers can and do contribute to an employee's HSA and the maximum contributions just stated include any portion contributed by an employer.

Your child's health insurance coverage

Any child may remain on the family health insurance plan up through age 26. After that, at the latest, the child will need a separate insurance plan. If the choice is an HDHP, then the child also can set-up his or her own Health Savings Account, too.

But keep in mind that there is a tax angle, here. Tax law allows parents to claim children as tax dependents (and exemptions) up through age 18. After that, from age 19 through age 24, the child can continue as a dependent, for tax purposes, only: 1) as a full-time student, 2) for whom you provide more than half of the financial support, and 3) who lives with you more than half the year. (Rules relating to a child with a disability differ somewhat.)

There is one additional point relating to your child's coverage. You cannot make HSA distributions for medical expenses of anyone who is not your tax dependent. Therefore, when you stop claiming your child on our taxes, you have to stop using your HSA for the child's medical expenses. This is something to keep in mind if you are maintaining health coverage for your children between ages 19 and 26.

Choosing an HSA

On their own, most children starting out probably won't choose to start an HSA. (Unless, of course, their employer has chosen that model for coverage.) If the child is not covered by an employer or another group plan, however, and seeks individual health insurance coverage, the benefits of the HDHP approach are worth discussing.

The high out-of-pocket (deductible) feature of HDHP insurance tends to benefit young, healthy individuals. They do not have regular, expensive medical care requirements. What they need is catastrophic coverage if an accident or unexpected serious illness strikes. An HDHP provides such coverage. But because ordinary medical expenses tend to be low, the premiums on HDHP insurance tend to be low, as well.

For an individual with a qualifying HDHP, opening an HSA has little downside risk. Although there is a maximum annual contribution, there is no minimum. (And few than 15 percent of people contribute the maximum to their HSA.) Money that the young man or woman does contribute is flexibility available for virtually all health-related spending not covered by the plan. If not spent, the money rolls over, accruing tax-free interest and capital gains year by year. If the plan is with an employer, it is fully portable from job to job.

On the other hand, if an individual decides to take a distribution from an HSA for any non-health-related expense, the distribution is taxed as ordinary income and there is a 20 percent penalty (much as in the case of an IRA). Because the majority of HDHP-HSA packages are through insurance companies, establishing them and being sure that regulations and limits are handled property is done by the company. (There is an option, however, to obtain the HDHP separately and then open the HSA with a bank.)

Health Savings Accounts were created, some 15 years ago, with the intention of giving individuals and families more control over their handling of health care expenses. To give them more flexibility in how they spend their medical insurance dollars. And to provide a strong tax incentive for taking responsibility for such spending. Those are features well worth discussing with your grown children.

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