High earners are always looking for ways to propel themselves forward financially. The 2018 US Trust Insights on Wealth and Worth found that 84% of high net worth households surveyed were extremely motivated to create wealth in order to provide financial security for their families. This can range from doing the right estate planning to simply being strategic and clever in how they utilize everyday retirement accounts.
Further, many high earners are finding that their children are staying on their payroll longer as they navigate the bridge to adulthood. With children experiencing a slower launch to independence than previous generations, these parents want to make choices that help keep their child on the path to financial independence and wealth building.
While many high earners help fund their child’s Roth IRA, there’s a unique technique regarding Health Savings Accounts (HSAs) that allows them to fund their child’s HSA at the higher family rate of $7,000 instead of the single payer rate of $3,500. To take advantage of this, many high earners have learned some of the hidden strategies of HSAs.
“There are several strategies that people have played with but a particularly powerful one deals with an adult child still covered under the parent’s health plan,” says Anna Kissick, Director of HSA Business Development at Liberty Savings Bank. “Many times, it is a way for parents to help their child in their ‘adult’ life with a healthy financial start.”
It would, in fact, be a very advantageous financial start. The difference between helping your child fund a single payer HSA at $3,500 versus helping your child fund an HSA at the higher $7,000 – even for just 3 or 4 years, could be the difference of $150,000 in growth of the funds, if invested, by the time the child is age 65. That provides a significant pool of funds that might even cover the majority of the child’s medical costs in retirement.
But there are a few key definitions and nuances that these high earners have mastered.
What’s A Dependent
To use this unique strategy for HSAs, it all comes down to how you define the word ‘dependent’. The term can have different implications for HSA strategies, based on whether we are discussing health care or taxes,
Under the Affordable Care Act, parents can keep their children on their health care policy until the child turns 26 years old. It’s a huge benefit to many families as their children start out in the world and the child is considered a dependent on their parents’ plan.
In comparison, under the tax code, parents may claim their child as a dependent provided they are a qualifying child, younger than 19 years old, or be a student younger than 24 years old, at the end of the calendar year. Further, the child cannot be another’s dependent, cannot file a joint return and must be a US citizen or national or resident alien. If these qualifications are met, then the child can be claimed on the parents’ tax return.
Here’s how high earners are using these definitions to their advantage in creating a unique HSA strategy: While the child is covered by the parents’ health care plan and is also a dependent on the parents’ tax return, they come under the parents’ HSA funding. This means the family can fund $7,000 for tax year 2019 (and with the catch up if the parent is over age 55).
Once the child is no longer claimed as a dependent on the parents’ tax return, they are not eligible to access their parents’ HSA for expenses. Here’s where the magic occurs.
“However, since the child is covered under a family plan, the child can open their own HSA and make a contribution equal to the family contribution limit for themselves,” says Kissick, who works with clients on these strategies. “Who actually funds the child’s account – the child or their parents, doesn’t matter. But only the child can deduct the contribution since it is her own account.”
Under this strategy, the parents would fund $7,000 for their HSA and the child would fund $7,000 in their HSA. A total of $14,000 could grow tax deferred and be used tax free for qualified medical expenses.
Kissick admits that this possibility seems surprising. “It feels like it is a double dip, tax-wise for the year. But it is a loophole that exists.”
A Limited Loophole
This loophole is available to families for a limited period of time. Most children don’t start claiming themselves until they are age 22 or 23. When children reach age 26, they can no longer be covered by their parents’ plan and need one of their own.
Once they are on their own single payer health care plan, their HSA contribution will be limited to $3,500. The ability to have your child fund an HSA at a higher level and then let it compound is only possible for a very short period of time, when they are still on the parent’s HSA. If taken advantage of, it could be the seed money for the children’s retirement medical strategy as well as an automatic emergency fund.
“If something big were to happen to the child, or their family, they have this savings that they can fall back on to help them through the crisis,” points out Kissick.
Managing the Risk of This Strategy
Taking on unique HSA strategies may not be without risk warns Kissick. “There are a lot of gray areas in relation to HSAs that have to be ‘interpreted’, which is normal in the tax world.”
Ultimately these unique planning opportunities should be vetted by your tax professional to make sure you qualify. But for high earners who take advantage of this technique, it can be a terrific step to propel their children to financial success.