Many organizations provide a health savings account (HSA) to their employees to offset rising healthcare costs. While HSAs are employee-owned accounts, many employers wonder if they can contribute to their employees’ HSAs, and—if so—how much.
Employers aren’t required to contribute to their employees’ HSAs, but many choose to do so. These popular accounts make an employee’s benefits package more attractive by reducing their healthcare costs, which aids in increased employee satisfaction and retention.
But employer contributions to HSA rules can be challenging to manage. There are two ways employers can contribute tax-free funds to their employees’ HSAs, but it’s important to understand how to do so compliantly.
What is an HSA?
Before we dive in, let’s talk about what an HSA is. An HSA—or a health savings account—is an account made up of both employee- and employer-contributed funds that can be used to pay for approved healthcare expenses, such as vision and dental care, prescriptions, and deductibles.
An individual or an employer can open an HSA, but the individual always owns the account, meaning HSA funds stay with the employee even after they leave their workplace.
An employer’s HSA contribution is excluded from an employee's income and isn’t subject to federal income tax, Social Security, or Medicare taxes. Also, according to HSA eligibility, employees can only contribute to their HSA if they’re enrolled in an HSA-qualified high deductible health plan (HDHP).
If both employer and employee contributions fund an HSA, the total contribution must remain within the annual IRS contribution limits. If the annual HSA contribution limit is surpassed, the excess contribution may be taxable to the employee.
HSAs are a unique health benefit with triple tax advantages:
- Tax-deductible contributions
- Tax-free accumulation of interest and dividends
- Tax-free distributions for qualified medical expenses
HSAs remain popular with employees because HSAs don’t expire, so the eligible individual can withdraw HSA funds to pay for qualified medical expenses at any time, making it an ideal retirement savings vehicle.
How does an employer contribute funds to an HSA?
Employer contributions to an HSA are optional, but most employers provide some funding for employees’ accounts, particularly during their first few years on the job. Having some kind of employer contribution makes the employer-sponsored HDHP more financially appealing to prospective job candidates with greater employee coverage.
HSA employer contribution happens in two ways—either with or without a Section 125 plan. Let’s go into more detail on both options below.
Option 1: Contribute with a Section 125 plan
A Section 125 plan, also known as a cafeteria plan, allows employees to take a portion of their income and put it toward qualified expenses, including HSA contributions, on a pre-tax basis. Employers can allow employees to contribute to their HSAs via payroll by adding a Section 125 plan with HSA deferrals as an option.
Setting up automatic payments simplifies and improves employee savings. Employers can also choose to contribute to their employees’ HSAs as part of the Section 125 plan.
The advantages to an employer for using a Section 125 plan combined with an HSA are:
- Employees can make HSA contributions through payroll deferral on a pre-tax basis
- Employees may pay for their share of insurance premiums on a pre-tax basis
- Employers and employees save on payroll tax
- Employers avoid the comparability rules for HSA contributions
- However, all contributions, including matching contributions, are subject to Section 125 nondiscrimination rules
Employers gain significant savings by allowing their employees to contribute pre-tax money to their own HSA via payroll deduction. Employee and employer contributions may be combined and forwarded directly to the savings institution for even more efficiency.
Option 2: Contribute without a Section 125 plan
Employers can still make a pre-tax contribution to their employees’ HSAs without a Section 125 plan. While Section 125 nondiscrimination rules don’t apply here, employers must still comply with comparability rules found in IRS Publication 969.
The comparability rules govern HSA employer contributions that aren’t made through a cafeteria plan. These requirements define how an employer structures their contributions and what they must do when employees fail to establish their HSAs on a timely basis.
To be comparable, employer contributions must be:
- The same dollar amount, or
- The same percentage of the HDHP deductible
The comparability rules apply to all employees in the same employment category, such as full-time or part-time, with the level of HDHP coverage, like single or family coverage. Employers who violate the comparability rules may receive a 35% tax on all HSA annual contributions.
Using a Section 125 plan for employer contributions provides more flexibility to set different HSA contribution amounts by employee categories. For this reason, plus the significant tax savings, employer HSA contributions are more beneficial in conjunction with a cafeteria plan.
Alternatives to HSAs
If you’re not sold on HSAs, then there are two great options to consider. An alternative to Section 125 plans and HSAs is a health reimbursement arrangement (HRA), also known as a Section 105 plan. You can also take the route of implementing a health insurance stipend. We’ll dive into both options below so you can learn how to further supplement your group health insurance plan.
An integrated HRA, also known as a group coverage HRA (GCHRA), is a perfect alternative to an HSA because it also integrates with group health insurance plans. An integrated HRA helps employers supplement their employees’ out-of-pocket medical expenses listed in IRS publication 502 that aren’t fully paid for in their group health plan.
With an integrated HRA, rather than pre-fund a savings or spending account, the employer sets a monthly allowance amount and keeps it until employees submit a reimbursement request.
Unlike HSAs, you don’t need an HDHP to use an integrated HRA, but it can help keep your costs down by bridging the gap between offering an HDHP and minimizing premium costs.
Like Section 125 plans, integrated HRA funds are tax-free. But employers don’t have any financial responsibility until an employee incurs an eligible medical expense making HRAs more cost-effective. Any unused funds at the end of the year stay with the employer.
Another way for employers to help workers cover healthcare costs is to offer a health stipend. A health stipend is simply a flat amount of money given to all employees that is added to their paycheck as extra wages.
A stipend’s distribution depends on the organization. Stipends can be paid out as a lump sum or on a recurring basis, such as weekly, monthly, or quarterly. Stipends can also be given up-front or offered as a reimbursement.
While a stipend is more straightforward to administer than an HSA or HRA, employers can’t require employees to prove they purchased healthcare items with their stipend money. Because the funds aren’t regulated, they can be spent however the employee chooses. Also, they are considered added income and are therefore subject to annual income tax requirements.
Taxable income aside, stipends are a great way to supplement your group health plan and give your employees more control over their healthcare expenses. They can entice candidates to your organization and improve productivity, resulting in a happier overall workforce.
Cafeteria plans are the most tax-advantaged way for employers to make ongoing employee HSA contributions. But if you’re not sold on HSAs, an integrated HRA or a health stipend are great ways for an employer to help employees with their medical expenses. These customizable benefits pack a punch and increase the power of your employee benefits package.
Making an informed decision about your health benefit can help you maximize value for both your employees and your company. If you’re ready to choose a personalized health benefit for your organization, schedule a call with PeopleKeep and we’ll get you started.
This post was originally published on November 13, 2020. It was last updated on March 14, 2022.