Question: What are the HSA contribution rules for different situations such as employee-only coverage, family coverage, catch-up eligible employees, employees who lose HSA eligibility mid-year, and employees who gain HSA eligibility mid-year?

Short Answer: In general, there are different HSA contribution limits based on employee-only vs. family coverage, whether the employee is age 55+, and the number of months in the year for which the individual is HSA-eligible. There is also a special rule referred to as the last-month rule that provides additional options for those gaining HSA-eligibility mid-year.

Note: This is the second in a two-part series addressing HSA eligibility.

• Part I: The HSA Contribution Rules

Starting Point: Only HSA-Eligible Individuals Can Establish and Contribute to an HSA
Health Savings Account (HSA) eligibility is required for any individual to open and make contributions to an HSA (e.g., through the employer’s payroll or as a direct deposit) or receive contributions to an HSA (e.g., the employer contribution made available to employees enrolled in the HDHP).

Individuals must satisfy the following four requirements to be HSA-eligible:

1. Be covered by a qualified high deductible health plan (HDHP);

2. Have no other disqualifying health coverage;

3. Not be enrolled in any part of Medicare; and

4. Not be able to be claimed as a dependent on someone else’s current-year tax return.

For more details:

• The HSA Eligibility Requirements: Part I

• The HSA Eligibility Requirements: Part II

• Newfront Go All the Way With HSA Guide

Contribution Limit for Partial Year of HSA-Eligibility: Standard Proportional Rule
The standard rule is that employees who are HSA-eligible for only a portion of the calendar year have a reduced HSA contribution limit. The reduced contribution limit is a proportional amount based on the number of months of HSA eligibility for the employee in the calendar year. HSA eligibility is determined as of the first day of each calendar month.

Example 1:

• Bryce enrolls in employee-only HDHP coverage with his employer on January 1, 2025 (and has no disqualifying coverage).

• Bryce changes to standard HMO coverage as of October 1, 2025 upon getting married, and he remains in that non-HDHP coverage through the end of 2025.

Result 1:

• Bryce is HSA-eligible for nine months of the calendar year.

• Bryce’s HSA contribution limit is therefore 9/12 (3/4) of the statutory limit.

• This means Bryce’s HSA proportional contribution limit is $4,300 x ¾ = $3,225

The IRS provides a useful chart and worksheet for determining an individual’s HSA contribution limit in the “Line 3 Limitation Chart and Worksheet” section of the Form 8889 Instructions. This worksheet also incorporates the proportional catch-up contribution amount, as well as how changes from individual to family coverage affect the contribution limit.

• For more details: The HSA Proportional Contribution Limit

Contribution Limit for Partial Year of HSA-Eligibility: The Last-Month Rule
Employees who enroll in the HDHP mid-year are generally subject to the proportional contribution limit above. However, a special rule known as the “last-month rule” (alternatively referred to as the “full contribution rule”) may apply to permit the mid-year enrollee to contribute up to the full statutory limit—even though the employee was not HSA-eligible for the full calendar year.

In order to qualify for the last-month rule, the employee must satisfy both of the following two conditions:

1. The employee is HSA-eligible on December 1 of the year at issue; and

2. The employee remains HSA-eligible for the entire following calendar year.

This creates a 13-month “testing period” that applies to determine whether the individual has met the last-month rule requirements. The mid-year HDHP enrollee must be eligible on December 1 through the entire subsequent calendar year to contribute up to the full statutory limit—as opposed to the standard proportional limit—for the year in which the employee enrolled in the HDHP mid-year.

Example 2:

• Kris enrolls in HDHP coverage on October 1, 2025 and is HSA-eligible continuously through the end of 2026.

Result 2:

• Kris can contribute up to the full statutory limit (as opposed to the standard proportional limit) in 2025 by taking advantage of the last-month rule.

• Kris qualifies for the last-month rule in 2025 because he was HSA-eligible in the 13-month testing period from December 1, 2025 through December 2026.

• If Kris had not qualified for the last-month rule (e.g., enrolled in a standard HMO in 2026), his 2025 contribution limit would have been 3/12 (1/4) of the contribution limit.

The IRS provides a useful summary of the last-month rule in Publication 969 and in the Form 8889 Instructions. Mid-year HDHP enrollees who contribute to the statutory limit but do not satisfy the 13-month testing period by failing to remain HSA-eligible will be subject to income taxes and a 10% additional tax on the amounts contributed in excess of the statutory limit.

• For more details: The HSA Last-Month Rule

Contribution Limit When Changing HDHP Tiers Mid-Year
The HSA contribution limits are calculated on a monthly basis. This means the employee is able to contribute 1/12 of the employee-only limit for the months of the year in employee-only HDHP coverage, and 1/12 of the family limit for the months of the year in family HDHP coverage. The employee’s overall annual contribution limit is the sum of those two prorated employee-only and family contribution numbers.

The coverage in effect as of the first day of each calendar month determines whether the employee has employee-only or family HDHP coverage for that month. The IRS provides a useful chart to complete this calculation in the “Line 3 Limitation Chart and Worksheet” section of the Form 8889 Instructions.

The last-month rule (described above) is also applicable in this context to permit individuals who move from employee-only to family HDHP coverage mid-year to contribute up to the full family limit if remaining HSA-eligible through the entire subsequent calendar year.

Example 3:

• Simone is enrolled in employee-only HDHP coverage through her employer from January – October 2025.

• In November, she moves to family HDHP coverage (employee + spouse) upon marrying her husband Jonathan.

• In January of 2026, Simone and Jonathan move to non-HDHP coverage through a standard HMO.

Result 3:

• Simone’s HSA contribution limit in 2025 is 10/12 of the individual contribution limit ($4,300 x 10/12 = $3,583.33) plus 2/12 of the family contribution limit ($8,550 x 2/12 = $1,425), which is a total of $5,008.33.

Example 4:

• Same as Example 3, however in this case Simone remains HSA-eligible throughout all of 2026.

Result 4:

• In this case, because Simone remains HSA-eligible for the full 13-month testing period from December 1, 2025 through the end of 2026, she can take advantage of the last-month rule in 2025.

• This means her contribution limit for 2025 is the full $8,550 (instead of the proportional $5,008.33 limit in Example 3).

For more details: HSA Limit for Partial Year of Family Coverage

Employee HSA Contributions: Pre-Tax Payroll Contributions
The most advantageous method for employees to contribute to their HSA is on a pre-tax basis through payroll. Nearly all employers offering an HDHP permit employees to make pre-tax HSA contributions. All employee pre-tax HSA contributions are made via the employer’s Section 125 cafeteria plan, which is the exclusive mechanism for taking these elections on a pre-tax basis.

• For more details: The Section 125 Safe Harbor from Constructive Receipt

The FICA Exemption for Employee Pre-Tax HSA Contributions Through Payroll
HSAs are frequently touted for their unique triple-tax advantaged status of pre-tax/deductible contributions, tax-free growth, and tax-free distributions for qualified medical expenses. Employee pre-tax contributions through the cafeteria plan have the additional advantage of avoiding FICA payroll taxes—making the benefit arguably quadruple-tax advantaged.

The FICA tax rates are 6.2% for Social Security, 1.45% for Medicare. That payroll tax exemption is even more meaningful for employees who do not exceed the FICA wage base for the 6.2% Social Security tax ($176,100 in 2025). Those who exceed the wage base still enjoy the 1.45% Medicare tax exemption (and potentially the ACA’s 0.9% additional Medicare tax at certain income levels).

Prompt Deposit Required
As a general rule, all employee HSA contributions must be “promptly” deposited into their HSA accounts. The rule of thumb is that prompt depositing means as of the earliest date in which the contributions can be reasonably segregated from the employer’s general assets, and in no event later than 90 days after the payroll deduction is made. Failure to timely deposit HSA contributions could raise a potential prohibited transaction under IRC §4975, which creates an excise tax liability of 15% of the amount involved and must be reported on IRS Form 5330.

• For more details: The Employee HSA Contribution Deposit Timing Requirements

The Prohibition of Front-Loading Employee HSA Contributions Through Payroll
The Section 125 cafeteria plan regulations that govern employee pre-tax HSA contributions require that the interval for employee salary reductions be uniform for all participants. Although it is not explicit in the regulations that salary reduction contributions be taken ratably, it would defeat the purpose of the uniform interval requirement to provide that employees may contribute different amounts at the set uniform interval.

Therefore, unlike with 401(k) deferrals, most view front-loading HSA contributions as not permitted under Section 125. Furthermore, any front-loading permitted by employers would create significant risks of excess HSA contributions under the proportional rule described above if the employee loses HSA eligibility mid-year.

Our recommendation is therefore that the employer should not permit employees to front-load their HSA contributions through payroll. The employer should instead implement the employee’s election ratably by taking the standard per-paycheck HSA contribution spread over the full plan year.

• For more details: The Prohibition of HSA Front-Loading

Employees May Change Elections Monthly Without Experiencing a Life Event
The Section 125 cafeteria rules provide that employers must permit employees to change their HSA contribution election at least once per month and for any reason. Employers may permit employees to change their HSA elections more frequently (e.g., once per pay period), but at a minimum it must allow employees to change their elections at least monthly. This is an exception from the standard Section 125 irrevocable election rule that otherwise requires employees to experience a permitted election change event to make mid-year election changes.

• For more details: HSA Contribution Election Changes

Employee HSA Contributions: Direct Contributions Outside of Payroll
Employees can also make HSA contributions outside of payroll by working with the HSA custodian to facilitate a direct contribution. The employee can take an above-the-line deduction on the individual tax return for any direct HSA contributions with after-tax dollars and receive the same income tax treatment as a pre-tax contribution through the cafeteria plan. (Note that the revised Form 1040 after TCJA moves the HSA above-the-line deduction, as well as many other common deductions, to Schedule 1.) Employees seeking to front-load their HSA contributions can always utilize this approach.

Direct Contributions Permitted by Tax Filing Deadline
Employees can make contributions to the HSA allocated to the prior year provided the contribution is made by the tax filing deadline (generally 4/15). Any such subsequent year employee contributions allocated to the prior year are made by outside of payroll as a direct contribution to the HSA custodian.

Correcting Mistaken Employer HSA Contributions
The general rule is that an employer cannot recoup any portion of its contributions to the employee’s HSA, which are nonforfeitable. However, there are three exceptions to that general rule whereby employers can request the HSA custodian refund any mistaken HSA contributions:

Mistaken Contribution Exception #1: Employee Was Never HSA-Eligible
If an employer contributes to the HSA of an employee who was never HSA-eligible, the IRS takes the position that the HSA never actually existed because it was not properly established. In that case, the employer can correct the error before the end of the calendar year by requesting that the HSA custodian return the contributions (adjusted for earnings and administrative fees) back to the employer.

Mistaken Contribution Exception #2: Employer Contributions Exceed Statutory Limit
If an employer contributes to an employee’s HSA in excess of the statutory annual maximum contribution limit, the employer may correct the error. In that case, the employer can correct the error before the end of the calendar year by requesting that the HSA custodian return the excess contributions (adjusted for earnings and administrative fees) back to the employer.

Mistaken Contribution Exception #3: Clear Documentary Evidence of an Administrative or Process Error
This third exception derives from an IRS Information Letter. It provides that where there is clear documentary evidence demonstrating that there was an administrative or process error, the employer can correct the error by requesting that the HSA custodian return the mistaken contributions (adjusted for earnings and administrative fees) back to the employer. In this situation, the employer should maintain the documentation to support its position that a mistaken contribution occurred.

• For more details: Correcting Mistaken Employer HSA Contributions

Correcting Excess Employee HSA Contributions
Where an employee has excess contributions that were not caused by an employer error or were not made through the employer’s payroll, the excess contributions are purely an individual income tax issue. There is no employer role in the correction process because the employer was not responsible for excess. The corrections are therefore handled directly by the employee in coordination with the HSA custodian.

Examples of where excess contributions may occur outside of the employer’s payroll include:

• Employee changed employers mid-year, and combined contributions exceed statutory limit;

• Employee made contributions directly to the HSA outside of payroll, and combined contributions exceed statutory limit;

• Employee and spouse contributions exceeded the combined family limit for spouses.

Even though a portion of the HSA contributions may have been employer/employee contributions through payroll, those contributions through payroll by themself did not create the excess. Accordingly, the employer does not have a basis to take corrective action.

• Note: Where an employee notifies the employer that the employee has reached or exceeded the maximum HSA limit because of contributions outside of the employer’s payroll (e.g., contributions through a prior employer or made directly to the HSA outside of payroll), the employer should discontinue all employer and employee HSA contributions. Although the employer is not responsible for taking corrective action, the employer should not knowingly permit employees to make or receive HSA contributions through payroll that are in excess of the statutory limit.

To avoid a 6% excise tax on the excess contributions when they file their individual income tax return, employees must work directly with the HSA custodian to take a corrective distribution of the excess contributions, adjusted for earnings. The earnings portion of the corrective distribution is included in the employee’s gross income, but there are no additional taxes. In other words, neither the 6% excise tax nor the 20% additional tax for non-medical distributions will apply.

The general rule is the employee must take the corrective distribution by the tax filing deadline (typically April 15), or the later deadline if filing for an extension (typically October 15), to avoid the 6% excise tax. The corrective distribution is reported on Line 14b of the Form 8889 filed with the individual income tax return. It is also reported as an excess contribution distribution (Code 2) in Box 3 of the Form 1099-SA provided by the HSA custodian.

• For more details: Correcting Excess HSA Contributions

Common Employer Restrictions on HSA Contributions
Employers frequently impose restrictions on employees’ ability to make or receive HSA contributions through payroll for administrative and budgetary reasons.

Employer HDHP Enrollment and Use of Designated Custodian
Employers almost always require that employees a) be enrolled in the employer’s HDHP, and b) establish an HSA with the employer’s designated HSA custodian to make or receive HSA contributions through payroll.

While it is possible for employers to permit employees to make or receive HSA contributions through payroll into any HSA custodian of the employee’s choosing—or based on enrollment in HDHP not sponsored by that employer--very few employers offer this option. Note that employees can freely move their HSA funds to any other HSA custodian via a rollover or transfer.

• For more details: Employer HSA Contributions

Deadline to Establish HSA with Designated Custodian
In some cases, employees will fail to timely establish an HSA with the employer’s designated custodian following HDHP enrollment. This is often because the employee has not completed the Customer Identification Program (CIP) to satisfy requirements set forth in the USA Patriot Act. The best practice approach for employers is to have a consistent policy to address situations or both active and terminated employees who do not take the steps required to open the HSA with the employer’s custodian.

For employee HSA contributions, the employer must either deposit or return the employee’s salary reductions. Employers can adopt any reasonable administrative policy for how to address employee withholdings where the employee does not timely open the account. For example, the employer may provide that failure to open the account within 90 days (or during the period of employment, if sooner) will result in a refund of the employee’s contribution to the employee in the following payroll. That avoids the need to hold and potentially refund large amounts of employee contributions. Remember that any refund must be taxable income subject to withholding and payroll taxes.

For employer HSA contributions, it is reasonable to have a consistent administrative policy providing that employees forfeit the employer contribution if they fail to timely open the account. For example, the employer may provide that the employee must establish the HSA within six months, and in no event beyond the last day of February of the following year or after the employee’s termination of employment. Outside of those limits, the employer will not make retroactive contributions if/when the employee eventually opens the HSA. The employer should include in employee communication materials describing the HSA benefit the consequences of failing to timely establish the HSA.

• For more details: Employee Fails to Timely Establish the HSA

California and New Jersey State Income Taxes
Almost all of the states conform to the triple tax-advantaged federal income tax treatment of HSA for purposes of state income tax law (or in some cases the state does not impose a state income tax, which makes this issue irrelevant). This means employees receive the same triple-tax advantaged benefit of HSAs at the federal and state tax income tax level.

However, there are two states that do not conform to the federal tax-advantaged treatment of HSAs: California and New Jersey. Therefore, although employee contributions to an HSA will be pre-tax for federal income tax purposes, contributions will be after-tax for state income tax purposes in California and New Jersey. This means the contributions are subject to state withholding and payroll taxes, and reported as taxable state income on the employee’s Form W-2 (Box 16).

• For more details: California and New Jersey HSA State Income Tax

Summary
The unparalleled triple-tax advantage of HSAs motivates many who are eligible to contribute to the maximum permitted. Employers and employees alike should be aware of the HSA contribution rules to avoid burdensome corrections or costly excise taxes.

Stay tuned for the next posts covering the HSA distribution rules!

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).