- An HSA is an employee-owned, employee-funded savings account that employees can use to cover eligible healthcare expenses.
- HSA contributions are not taxed by the federal government or most states, resulting in tax savings for both employers and employees.
- HSAs have strict eligibility guidelines, as well as penalties for over-contribution or misuse of funds.
- This article is for employers or human resources professionals who want to learn more about health savings accounts (HSAs) before offering them to their employees.
Offering a competitive employee benefits package with comprehensive healthcare options is a great way to attract and retain top talent. In addition to medical, dental and vision insurance, many businesses choose to offer supplemental healthcare savings options, like a health savings account (HSA). HSAs are not mandatory, but they are desirable because they allow employees to save generally tax-free money for eligible healthcare expenses.
What is a health savings account (HSA)?
A health savings account is an employee-owned savings account that workers fund through generally tax-free contributions. Although the federal government and most states do not tax HSA contributions, there are few exceptions like California and New Jersey. There are limits to how much can be saved into an account each year: $3,550 for individuals and $7,100 for families. Employees 55 and older can contribute an additional $1,000 per year in catch-up funds.
The employee can manage, invest in and withdraw money from an HSA, as well as use it to pay for qualifying medical, dental and vision expenses for themselves, their spouse or eligible dependents. Since an HSA is owned by the employee, they keep it even if they leave their company. All funds stay in the HSA until used.
Kathy Berger, principal benefits consultant at ThinkHR and Mammoth, said there are strict Internal Revenue Service (IRS) rules on eligibility, contributions, taxes and qualified healthcare claims for HSAs.
For example, to be eligible to make HSA contributions, and/or receive contributions made by the employer, employees must meet the following four conditions:
- They must be covered under a qualifying high-deductible health plan (HDHP).
- They cannot be covered under any disqualifying non-HDHP health coverage.
- They cannot be enrolled in Medicare.
- They cannot be claimed as another person's tax dependent.
Key takeaway: An HSA is an employee-owned, employee-funded savings account that employees use to pay for eligible medical expenses.
When and why to offer employees an HSA
If your company has a qualifying HDHP as a health insurance option, it is usually wise to offer an HSA alongside it. Although some companies offer HDHPs as their only group health plan option, most employers give employees a choice between a qualifying HDHP (with an HSA) and a non-HDHP. This lets employees choose a medical plan and savings account that works best for them.
"Both employers and employees realize reduced premium costs and additional tax savings when an employer offers a qualifying high-deductible health plan with a health savings account feature to employees," Amy Christen, an employee benefits attorney and a member of Dykema Gossett, told Business News Daily.
Additionally, offering a qualifying HDHP with an HSA option can lower your overall costs of providing healthcare benefits to your workforce. An HDHP can be considered a consumer-driven healthcare option; it encourages employees to become more thoughtful in their healthcare decisions, since they are responsible for a larger portion of their costs by having to meet higher deductibles.
"Consumer-driven healthcare incentivizes individuals to not immediately seek expensive medical care for all conditions (e.g., ER visits) and instead to visit less-costly providers at regular appointments," Christen said. "In turn, the employer's overall costs of providing healthcare benefits to its workforce should decrease."
Key takeaway: If you have an HSA-qualifying HDHP as a group health insurance option, offer an HSA so employees can cover medical expenses and premiums with generally untaxed income.
Are employers required to contribute to an HSA?
No, employers do not have to contribute to employee health savings accounts, but they can. HSAs are largely funded through pretax employee contributions, but employers that do choose to contribute funding can write off those contributions as a business expense. Employers can contribute a set amount or match the employee's contribution.
The IRS limits the total amount that can be contributed to an HSA each year, regardless of who is contributing. The HSA contribution maximums are $3,550 per year for individuals and $7,100 per year for families. Employees age 55 or older can elect an additional $1,000 per year in catch-up contributions. If employers and employees both contribute to an HSA, it is important to keep track of how much is being contributed. Any contributed funds that exceed the limits are not tax-deductible and can be subject to a 6% excise.
Key takeaway: Employers aren't required to contribute to HSAs, but they have the option to, as long as combined contributions remain under the maximum annual limits.
What are the differences between an FSA and an HSA?
If you are considering adding an HSA to your benefits offerings, you may also be researching healthcare flexible spending accounts (FSAs). Although the two types of accounts serve the same purpose – to cover eligible healthcare expenses through pretax income – both have their own guidelines and requirements. It is important to evaluate what each plan offers in comparison to what your employees need.
This chart shows some of the differences between an FSA and an HSA:
|Healthcare flexible spending account (FSA)||Health savings account (HSA)|
|Eligibility requirements||Any employee, unless otherwise specified by the employer||Employees who meet the following: Enrolled in an HSA-qualifying HDHP, not covered under any disqualifying non-HDHP health coverage, not enrolled in Medicare, and not claimed as another person's tax dependent|
|Contributions||Employee-funded (employers may contribute)||Employee-funded (employers may contribute)|
|Annual contribution limit||$2,750||$3,550 (individual) and $7,100 (family)|
|Do funds roll over to the new year?||Partially (up to $550 rollover or up to 2.5-month grace period for unused balance, if allowed by employer)||Yes (Employee keeps all unused funds)|
|Portability after termination||No (FSA stays with the employer)||Yes (HSA stays with the account holder)|
Key takeaway: FSAs and HSAs serve similar purposes, but they differ in employee eligibility, account ownership, contribution limits and portability.
What are the pros and cons of HSAs for employees?
To determine whether an HSA is the best option to offer your employees, weigh the pros and cons against your team's needs. The primary benefits include tax savings and account perpetuity, and the primary limitations are strict guidelines and penalties.
Pros of HSAs for employees
HSAs offer tax savings for employees (and employers).
The primary reason many employees opt for a health savings account is to take advantage of the tax savings. Employers that choose to contribute to HSAs also receive tax savings. HSA contributions are untaxed and can receive a triple tax advantage under federal law. Most state tax laws mirror federal laws, although there are some exceptions, such as in California and New Jersey.
"First, the employee's eligible contributions are exempt from federal income and payroll taxes (e.g., Social Security and Medicare taxes)," said Berger. "Secondly, federal taxes do not apply to HSA earnings, such as interest, dividends, and investment gains. Thirdly, when HSA funds are withdrawn to pay qualified health expenses, the amounts are not taxed."
HSAs are employee-owned, portable accounts.
Unlike other tax-advantaged healthcare accounts, such as health reimbursement accounts and FSAs, an HSA is owned by the employee. All funds stay in the account until they are used, and the account is portable, meaning the employee keeps ownership over it even if they leave the company. This sense of security is desirable for many employees and can be beneficial to your recruiting strategy.
"HSAs are portable, and there is no 'use or lose' rule," said Berger. "The four eligibility conditions must be met in order to make HSA contributions, but the account is not affected if the employee later loses eligibility. The employee can continue holding, investing and using the account, but cannot make new contributions unless eligible."
Cons of HSAs for employees
Employees have to have a qualifying HDHP.
To be eligible for an HSA, an employee must have an HSA-qualifying HDHP. Although HDHPs have the advantage of lower premiums, they often come with high deductibles, which can be expensive for employees who need medical care. In 2020, an HDHP's annual deductible must be at least $1,400 for individuals or $2,800 for families. Many employees don't fully understand the implications of enrolling in an HDHP.
"Low-wage earners often will not have disposable income to contribute to an HSA, even given the pretax income and FICA savings, and may not have the resources to fund the high deductible expenses out of pocket before their qualifying HDHP coverage kicks in," Christen said.
HSAs come with strict IRS guidelines and penalties.
The IRS has complex rules and restrictions for establishing an HSA, along with various reporting obligations on employers and employees for maintaining HSAs. Notably, only eligible employees with qualifying HDHPs can open health savings accounts.
"For example, an employee will not be considered an eligible individual for purposes of making or receiving HSA contributions when the employee's spouse is enrolled in a general-purpose health flexible spending account (FSA) which reimburses the spouse for eligible healthcare expenses of the spouse and family members (including the employee), or the employee has received VA health benefits in the last three months, or the employee enrolls in Medicare (which may be automatic under some circumstances)," Christen said.
The IRS also sets limits for how much money can be contributed to an HSA each year. If the HSA contributions exceed the annual limit, a potential 6% excise tax can be imposed against the HSA account holder. The IRS may also impose penalties if employees spend the HSA money on nonqualifying expenses; these penalties include income tax and a 20% excise tax on the nonqualifying amount.
Key takeaway: HSAs are great for tax savings and employee financial security, but they come with strict guidelines and penalties for misuse.
How to set up an HSA for employees
As mentioned previously, employees must be enrolled in a qualifying HDHP to open an HSA. Keep in mind, however, that not all HDHPs are eligible for HSAs, so you will have to verify that you are offering a qualifying HDHP.
Employers aren't required to set up HSAs for their employees, but the vast majority of employers with qualifying HDHP options assist employees in establishing their HSAs by selecting one or more HSA vendors to set up the accounts with employees, Christen said. Those vendors are often linked to the employer's payroll to directly receive employee and employer contributions.
When you are helping employees set up an HSA and select an HSA vendor, there are a few legal considerations to be aware of, especially regarding benefits protection laws such as the Employee Retirement Income Security Act (ERISA).
"The employer should work with its ERISA counsel to ensure that the employer is not inadvertently turning the HSA into an employer-sponsored health plan (of course, the qualifying HDHP is itself an employer-sponsored plan, but the HSA typically is not such)," Christen said.
Key takeaway: To set up HSAs, ensure your employees have an HSA-qualifying HDHP. Then, select an HSA vendor to link to your payroll, and walk your employees through the setup process.