Anyone just learning about health savings accounts, or setting one up for the first time, has to figure out a somewhat-complicated set of federal rules governing the accounts.

For example:

• In order to open and own an HSA account, you must have a high-deductible health plan (HDHP), you’re no longer eligible if you change your health insurance plan to non-HDHP coverage, and you can no longer contribute funds if you’re on Medicare.

• There are HSA contribution limits for each calendar year set by the IRS, with different maximum contributions for individuals and families (and those over age 55 get to make extra catch-up contributions).

• Excess contributions over the annual contribution limit aren’t tax-deductible and are subject to a six percent excise tax as well.

• The funds in an HSA can only be withdrawn tax-free to pay for federally-defined qualified medical expenses.

Some of these terms may be foreign or confusing, but once you gain a little more familiarity with them, the concept is more straight forward than it seems.

There’s another IRS rule governing health savings accounts, though, that can confuse even financially-literate account holders: the HSA “last month” rule.

What the HSA "Last Month" Rule Says

Here’s the “Last Month” rule for HSA accounts, quoted directly from IRS Publication 969:

“Under the last-month rule, you are considered to be an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers). If you meet these requirements, you are an eligible individual even if your spouse has non-HDHP family coverage, provided your spouse’s coverage doesn’t cover you.”

What exactly does this mean?

This is government-speak that provides important clarifications on what you can do with your health savings account, if you’re not covered under an HSA-eligible health plan for an entire year.

Here’s what they’re actually saying.

How the "Last Month" Rule Helps You Save

The powerful triple-tax benefits of a health savings account are best realized when you maximize your contribution amounts each year. It makes sense to put your full annual HSA contribution into your account, as soon as you’re eligible to do so.

But what if you obtain HDHP coverage and open an HSA later in a calendar year? Is a maximum contribution still allowed?

Let’s consider this scenario:

Say you take a new job (with health insurance) late in the year, and you’re not covered under their HSA-eligible health plan until November of 2020.

• Can you still put the full contribution amount for the year into your HSA account?

• Are you only allowed to make a prorated contribution for the two months you were eligible for that year?

• Or are you just out of luck for the year?

The "last month" rule answers this question.

If your HSA eligibility begins by the “first day of the last month” of the year – which would be December 1 – you’re considered an “eligible individual.” That means you’re allowed to put that year’s total contributions, for the full year, into your HSA. You don’t have to prorate your contributions, because you’ve “snuck in” under the deadline.

But what happens if your HDHP coverage doesn’t take effect until December 2? Sorry, you can only contribute a prorated amount for the period you were eligible. That amount is calculated by the “sum of the monthly contribution limits rule” – which we will save for a different time.

There is one other phrase in the “last month” rule that contains one important exception: if you’re still covered under someone else’s non-HDHP health care coverage after December 1, you can’t take advantage of the rule to make HSA contributions for that year.

The “last month” rule seems more than reasonable – but there’s a catch.

The Testing Period

Anyone who makes use of the “last month” rule to maximize their HSA contributions is required to remain an “eligible individual” for the next twelve months, referred to by the IRS as the "testing period."

In other words, if you become eligible under an HDHP by December 1, you have to remain covered by an HDHP until December 31 of the following year (the last day of the 12th month). If you change or lose your insurance coverage before then, and you’re no longer HSA-eligible, you’re stuck with additional taxes and penalties on the contributions you made under the “last month” rule.

How much will you owe? Since this is the IRS we’re talking about, there is most definitely a form for that. You can find this information on the Line 3 Limitation Chart and Worksheet on Tax Form 8889 that should be filed with your tax return as an HSA contributor.

Based on this rule, you will see that:

• The excess amount contributed to the HSA has to be counted in the last year’s taxable income and is subject to normal income tax.

• The excess amount is subject to an additional 10 percent penalty.

There’s definitely a risk involved in using the “last month” rule to maximize HSA contributions. It’s important to assess both your financial situation and your job security in the event that your health insurance is dependent on your employer.

It could be a good idea to wait on contributions, if you think that you could be changing jobs or personal status during the Testing Period (for example, getting married or switching to coverage under a partner’s insurance), or that your employer may change available health plans (such as eliminating individual or family HDHPs, or instituting FSA plans instead).

If there’s some uncertainty in your situation, you might want to stash the contribution amount in a non-HSA account, holding it there until the last possible moment (April 15) that you’re allowed to make a mid-year HSA contribution for the prior year. By then, your status for the rest of the Testing Period could be clearer.

For more information on the “last month” rule and Testing Period, check out Lively's comprehensive FAQ and get answers to the questions you may have before opening or contributing to an HSA. Lively’s HSA provides the best investment options and most flexibility available anywhere – and once you’re past the question stage and ready to open an HSA, your Lively account can be ready in just minutes.