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Updated: April 18, 2024
A health savings account, or HSA for short, is a type of medical savings account that allows individuals to save money on a pretax basis to pay for qualifying healthcare expenses. These include deductibles, coinsurance, co-pays, and a long list of other medical costs.
Using pretax dollars to pay for qualifying medical expenses can help lower out-of-pocket costs, thus making healthcare more affordable. HSAs offer triple tax advantages: Not only are contributions made pretax, but earnings accumulate tax-free and distributions are tax-free, if the money is used to pay for qualifying medical expenses.
In this employer’s guide, we will go over how HSAs work, the tax implications of contributing to them, some advantages and disadvantages, and how HSAs can help bridge the retirement savings gap.
One easy way to understand HSAs is to think of them as 401(k)s for healthcare. Similar to 401(k) contributions, individuals contribute pretax money to their account — or money that they haven’t paid income tax on yet — usually through payroll deductions.
Employers can also make contributions to employees’ accounts, similar to matching 401(k) contributions. Nearly 80% of employers that offer HSAs also contribute to their employees’ accounts, according to the Plan Sponsor Council of America.
In fact, according to the 2022 Year-End Devenir HSA Research Report, 26% of HSA contributions were made by employers, annually averaging $869.00 per employee, while 63% of HSA contributions were made by employees, annually averaging $2,147.00. In 2022, a total of $47 billion was contributed to and $34 billion was withdrawn from HSAs in 2022.
So, what happens once savings are built up? While money saved in an HSA usually cannot be used to pay health insurance premiums, it can be used to pay for a wide range of healthcare expenses, including many of the items in the table below:
HSA eligible expenses |
|
Deductibles, coinsurance, and co-pays associated with health insurance. | Prescription and over-the-counter medications. |
Medical equipment such as wheelchairs, crutches, hearing aids, and bandages. | Counseling, psychiatric, and mental health services. |
Physical therapy, rehabilitation, and acupuncture treatments. | Feminine hygiene products. |
Dental and vision care including cleanings, fillings, crowns, orthodontics, eye exams, glasses, and laser eye surgery. | Preventive care including annual physical exams and other types of routine health screenings. |
Long-term care services. | Healthcare expenses for dependents. |
It’s worth noting that if HSA funds are withdrawn before age 65 and used for non-qualifying healthcare expenses, they are taxed at the individual’s ordinary income tax rate and also subject to a 20% tax penalty. The penalty does not apply to non-qualifying healthcare withdrawals after age 65, but these withdrawals are taxed at ordinary income tax rates.
Also, there are a few instances in which HSA funds can be used to pay health insurance premiums:
Now that we better understand the basics around HSAs and what they are used for, let’s talk about who typically can participate in these types of plans.
Simply put, the main requirement for opening and contributing to an HSA is being enrolled in a high-deductible health plan (HDHP). As the name implies, this is a type of health insurance with a relatively low premium and a high deductible, or amount that individuals must pay before the insurance kicks in.
HDHPs are also referred to as HSA-eligible plans — here are some numbers that employees may want to know:
The minimum HDHP deductible in 2024 is:
The limit on out-of-pocket HDHP expenses in 2024 is:
In addition, the other requirements for opening an HSA are:
Once an individual enrolls in Medicare, HSA contributions are no longer permitted. However, HSA funds can be withdrawn by Medicare enrollees to pay for qualified healthcare expenses that Medicare or Medicare Supplement Insurance (Medigap) policies don’t cover.
HSA funds can also be used to pay Medicare Part B and Part D premiums, and to pay premiums for employer-sponsored health insurance for individuals 65 years of age and over.
In most cases, health savings accounts that are offered by employers typically are established as part of a Section 125 cafeteria plan, which allows employees to make tax-deferred contributions via payroll deductions.
Here are are some common steps to getting an HSA set up:
Here are some details on how much staffers can contribute (which most employees will want to have an idea about):
Note that these limits apply to combined employer and employee contributions. For example, an employee could contribute $2,075.00 to his or her account, and the employer could contribute an additional $2,075.00.
What if you have spouses that work for the same company? They are both able to contribute to an HSA, but they must be separate accounts, as joint HSAs between spouses aren’t permitted. However, spouses can use funds in each other’s accounts to pay for their own healthcare expenses.
With that primer on how accounts get off the ground and who qualifies, let’s talk about some of the things employers will consider before offering an HSA.
Health savings accounts offer benefits as well as potential drawbacks for employers and employees.
Benefits of HSAs for employers
Potential drawbacks of HSAs for employers
Benefits of HSAs for employees
Potential drawbacks of HSAs for employees
Employee contributions to HSAs are typically made on a pretax basis, so the money is not included in gross income, and is not subject to federal or typically state income tax.
Why will this get your team’s attention? Because it lowers employees’ tax liability for the year, which is one of the key employee benefits of HSAs. In some instances, employees may choose to contribute after-tax funds to an HSA instead of pretax money, and deduct the contributions from income when filing their tax return.
In addition, interest and earnings on HSA savings accumulate tax-free, which can boost the value of the account over the long term. This also helps individuals build up a sizable nest egg to pay healthcare expenses in retirement.
Finally, withdrawals from HSAs are not subject to federal, or typically, state income tax if the money is used to pay for qualifying healthcare expenses. Penalties are assessed on withdrawals before age 65 if the money is used for non-qualifying healthcare expenses, and the money is taxed at ordinary income tax rates.
HSA contributions made by employers are tax-deductible as a business expense, which can lower the company’s annual tax liability. Employers don’t have to pay federal income, FICA, or FUTA taxes on contributions to employees’ HSAs, since contributions aren’t considered wages.
Several studies have found that there’s a significant retirement savings gap in America. The World Economic Forum projects that this gap could reach $137 trillion by 2050, and that most U.S. retirees will outlive their retirement savings by a decade.
What’s more, according to a study commissioned by the Federal Reserve, one out of four Americans don’t have any money saved for retirement. The retirement savings gap is connected at least in part to rising healthcare costs (and the rise in state-mandated retirement plans). According to the Fidelity Retiree Health Care Cost Estimate, in 2023, an average retired couple of age 65 may need approximately $315,000 saved (after-tax) to cover healthcare expenses.
However, it’s not all doom and gloom, as HSAs can play a role in helping fill the retirement savings gap. Since unused funds roll over every year and can be invested to earn market returns, individuals and couples can build up a sizable retirement healthcare nest egg.
However, most HSA account holders aren’t maximizing potential long-term returns on their funds. According to EBRI, fewer than 20% of account holders view their HSA as an investment vehicle, and just 12% invest their money in assets other than cash (e.g., stocks, bonds, or mutual funds). It’s up to employers to educate employees about all of the potential uses of their HSAs.
One strategy is to offer employees a flexible match plan that helps them maximize the benefits of their 401(k) plan and their HSA, depending on their individual situation. With this type of plan, employees can choose whether the employer match is made to their 401(k) or their HSA. This will enable employees to grow their assets across different account types, giving them more financial flexibility. Remember: after age 65, HSA funds can be used penalty-free for non-medical expenses, though income taxes are assessed at ordinary income tax rates.
Health savings accounts offer numerous benefits to both employers and employees, including valuable tax breaks. Employees enjoy triple tax benefits: pretax contributions along with tax-free earnings and distributions. And employers can deduct contributions they make to employees’ HSAs as a business expense.
What’s more, HSAs can be a powerful employee recruiting and retention tool, which is especially important as companies seek to attract and retain top talent. Talk to your executive team about whether offering an HSA might be a smart strategy for your business and employees.
Please note all material in this article is for educational purposes only and does not constitute tax, health benefits or legal advice. You should always contact a qualified tax, legal or financial professional, in your area for comprehensive tax or legal advice.