Health savings accounts (HSAs) were introduced in 2003 as a tax-advantaged way to save money toward future health expenses. Although they’re opened, owned, and maintained by individuals, they’re also a valuable component of a comprehensive health benefits package.
Many businesses aren’t sure where to start when offering an HSA benefit, though.
In this post, we’ll discuss how an HSA works, the benefits of contributing to employees’ HSAs, how to do so, and which rules you need to follow if you offer an HSA with a health reimbursement arrangement (HRA).
Let’s get started.
What is an HSA and how does it work?
A health savings account (HSA) is a financial account established by an individual or family. The account’s funds can be used to pay for qualified medical expenses tax-free.
HSAs are similar to flexible spending accounts (FSAs), but with some major tax differences. With an HSA, you can:
- Make contributions 100 percent tax-free.
- Withdraw funds tax-free for qualified medical expenses, such as copays, deductibles, and medical office visits (see a full list of qualified expenses in IRS Publication 502).
- Earn any interest or dividends tax-free.
- Defer taxing any reimbursements indefinitely without penalties.
To contribute to an HSA, individuals must be covered by an HSA-qualified high-deductible health plan (HDHP).
Generally, HSA contributions are made along with regular pay. If an individual is making a contribution, they can set up a pre-tax withdrawal from their paycheck that will be deposited into the HSA. Businesses may do the same.
Both individuals and businesses must abide by the HSA’s annual contribution limits. For 2019, single account holders can contribute up to $3,500 and account holders with a family can contribute up to $7,000. There is also a catch-up contribution available of $1,000 for those over age 55.
Why should my business contribute to employees’ HSAs?
Although many businesses think of health benefits as simply a group health insurance policy or a stand-alone health reimbursement arrangement (HRA), employees often have a more expansive view. Increasingly, that view includes HSA contributions.
Today, more than 25 million Americans have an HSA account and they appreciate any additional contributions they receive.
HSAs are also one of the most effective ways small business owners can maximize their tax benefits. All contributions to an employee’s HSA count as a federal income tax deduction for your business. Additionally the contributions your employees make are done before tax, meaning you won’t pay payroll taxes (including FICA and unemployment taxes) on that amount.
And of course, all amounts your employees pay into their HSA are free of income tax.
HSAs are especially useful when combined with an HRA. HRAs like the QSEHRA are subject to federal limits—in 2019, the QSEHRA has limits of $5,150 for single employees and $10,450 for employees with a family. Offering both an HSA and a QSEHRA is a great way to maximize tax-free compensation to employees by up to $7,000. It also ensures that money goes toward one of employees’ heaviest financial burdens.
Finally, an HSA benefit can help your business with recruiting and retention, as many of your current and prospective employees will have an account and appreciate the contribution.
How to contribute to employees’ HSAs
Logistically, contributing to employees’ HSAs is simple. Here’s a five-step guide:
- Decide who will receive HSA contributions. To be eligible for HSA contributions, employees must have a health savings account through a qualified high-deductible health plan. This could be the company’s group health insurance policy or, if you’re offering an HRA, the individual policy the employees purchased themselves. Beyond this, businesses can structure HSA benefit eligibility by three classes: full-time, part-time, and former employees.
- Choose employee contribution amounts. Businesses can structure their HSA contribution amounts by the same three classes. In 2019, individuals can contribute up to $3,500 to their HSA while families can contribute up to $7,000. Your business should keep these limits in mind when choosing your own contribution amounts. You’ll also need to decide whether to contribute the funds in a lump sum at the beginning of the year or to disperse the funds on a monthly basis.
- Set up a Section 125 plan. A Section 125 cafeteria plan allows employees and businesses to contribute pre-tax dollars to an HSA. You can do this on your own, through a payroll provider, or through a software administrator.
- Direct business and employee contributions to HSA custodian. Part of your responsibility in contributing to and collecting employee HSA deferrals is directing the payments to the right place. Your employees will have their HSA administered through a custodian, such as a bank; it’s your responsibility to ensure payments are sent to the account without delay.
- Coordinate appropriate tax documents. At the end of each tax year, you’ll need to ensure both your business and its employees have the appropriate tax documents, including the employees’ W-2s.
How to contribute to HSAs with an HRA
An HSA can be used alongside a health reimbursement arrangement (HRA), but the HRA must be adjusted to accommodate the HSA.
If you choose to offer both an HRA and an HSA (and you should), you’ll need to make these adjustments.
Specifically, you’ll need to ensure that all employees with an HSA receive no coverage from the HRA until they meet the HDHP’s annual deductible. There are exceptions for five categories:
- Health insurance premiums
- Wellness or preventive care
- Dental expenses
- Vision expenses
- Long-term care premiums
The easiest way to ensure compatibility is to convert the HRA into a limited-purpose HRA. With a limited-purpose HRA, your employee can only be reimbursed through the HRA for expenses that fall into the five stated categories.
Offering HSA contributions is one of the easiest and most effective ways businesses can improve their health benefits offering.
HSA contributions deliver value to the employee, provide tax benefits for the business, and help businesses recruit and retain valuable workers. What’s more, setting up an HSA contribution and maintaining it is simple.
Have any questions about HSA contributions? Let us know in the comment section below.