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Updated: May 24, 2024

HSA how-to on health savings accounts: Employers and employees' shared advantages

Published By:

Jon Davis

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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.

Fast facts about health savings accounts (HSAs)

  • At the end of 2022, nearly 72 million Americans were covered by 35.5 million health savings accounts
  • Account holders over age 50 had accumulated more than $56 billion in HSAs at the end of 2022, while one in five Americans in their 30s had an HSA at this time
  • HSAs offer triple tax benefits: contributions are made pretax, earnings accumulate tax-free, and withdrawals are tax-free if used to pay for qualifying medical expenses
  • To open an HSA, individuals must also be enrolled in a high-deductible health plan (HDHP)

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.

Explaining what a health savings account is

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 In 2022, a total of $47 billion was contributed to and $34 billion was withdrawn from HSAs in 2022.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:

  • An individual is receiving federal or state unemployment benefits.
  • An individual is paying for COBRA continuing health coverage after leaving a job to continue receiving health insurance from the previous employer.
  • An individual is 65 years of age or over and on a retiree medical plan other than a Medicare supplemental policy.

 

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.

Who qualifies for a health savings account?

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:

  • $1,600.00 for individuals
  • $3,200.00 for families

 

The limit on out-of-pocket HDHP expenses in 2024 is:

  • $8,050.00 for individuals
  • $16,100.00 for families

 

In addition, the other requirements for opening an HSA are:

  • Individuals cannot be enrolled in any other type of health coverage
  • Individuals cannot be enrolled in Medicare
  • Individuals cannot be claimed as a dependent on anyone else’s tax return

 

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.

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Health savings account setup and contributions

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:

  1. First, the employer chooses the HSA provider (it could be a bank, credit union, or other financial institution) and sets up and manages accounts for employees. The process starts with the administrator verifying eligibility to ensure that the employee is enrolled in an HDHP, and meets the other criteria listed above.
  2. Next, the administrator will collect personal identification and tax information from the employee and use this to set up the employee’s account with the HSA provider. This includes filling out required documentation and ensuring compliance with IRS regulations.
  3. Once the account is set up, the employer and employee can both start making contributions. This process is overseen by the administrator to make sure that contributions don’t exceed annual limits and meet all other IRS requirements.

 

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.

What are the benefits and drawbacks of HSAs?

Health savings accounts offer benefits as well as potential drawbacks for employers and employees.

 

Benefits of HSAs for employers

  • HSAs can be a powerful employee recruiting and retention tool. Today, many employees want to work for companies that offer this kind of healthcare benefit
  • Employer HSA contributions are tax-deductible as a business expense, which can lower the company’s annual tax liability
  • Since contributions aren’t considered wages, employers don’t have to pay federal income, Social Security, or Medicare (FICA) taxes or federal unemployment (FUTA) taxes on contributions to employees’ HSAs
  • Offering an HSA along with an HDHP can be less expensive than offering a traditional health insurance plan
  • There are minimal reporting requirements since HSAs are not subject to the Employee Retirement Income Security Act (ERISA). However, employers must  make sure that HSA contributions are accurately reported on employees’ W-2 forms

 

Potential drawbacks of HSAs for employers

  • Some employees may balk at having to enroll in a high–deductible health plan plan before they can participate in an HSA,, due to the potentially high out-of-pocket costs they might face
  • According to a recent report by the Employee Benefits Research Institute (EBRI), most HSA account holders are not taking full advantage of their plans. As a result, they are missing out on substantial benefits. For example, average HSA contributions are well below the maximum amounts allowed, the report notes, and only 13% of account holders invest their money in assets other than cash
  • Employers may have to commit to intervals of education for account holders who may not fully understand how HSAs benefit them. A 2023 Plan Council of America study found that 58.3% of employers list employee education as a top concern when offering HSAs, though this number has fallen from 70% in 2021

 

Benefits of HSAs for employees

  • As we touched on earlier in the article, HSAs offer triple tax benefits: (1) contributions are made pretax, (2) earnings accumulate tax-free and, (3) distributions are tax-free if the money is used to pay for qualifying medical expenses
  • Unlike flexible spending accounts (FSAs), with HSAs, there are no “use it or lose it” consequences. Unused HSA funds rollover each year, which can allow participants to build up a sizable healthcare retirement nest egg. Conversely, FSAs feature restrictions on annual rollovers of unused funds
  • HSA funds are portable. Employees take their money with them when they change jobs or retire
  • HSA funds can be used to pay healthcare expenses for spouses and dependents, even if they aren’t covered by the HDHP
  • HSA funds can be invested to earn interest or market returns, just like 401(k) funds, which can help the account grow over time
  • At death, unused HSA funds that remain in the account can be bequeathed to a spouse, who would retain the tax benefits. If the money is bequeathed to someone other than a spouse, taxes will be due on the account balance
  • Employees typically receive a debit card that they can use to pay for qualifying healthcare expenses, which makes tapping HSA funds convenient and easy. Employees can even reimburse themselves from their HSA if they used another form of payment to pay a medical expense
  • Unlike traditional 401(k)s and IRAs, HSAs are not subject to required minimum distributions (RMDs). When they turn age 73, these require account holders to start withdrawing money from their retirement account

 

Potential drawbacks of HSAs for employees

  • Before age 65, there are penalties for withdrawals from HSAs if the money is used for anything other than qualifying healthcare expenses, along with taxation of the money. This reduces financial flexibility if an individual has a non-healthcare related financial emergency
  • High-deductible health plans could result in individuals having to pay large out-of-pocket amounts of healthcare expenses before their insurance kicks in. In 2024, this could be as high as $1,600 for individuals and $3,200 for families. The limit on out-of-pocket HDHP expenses in 2024 is $8,050 for individuals and $16,100 for families
  • In case they are ever audited by the IRS, individuals must keep detailed records and receipts documenting that withdrawals were used to pay for qualifying healthcare expenses
  • Some HSAs charge monthly maintenance or transaction fees. However, these may be waived if a minimum balance is maintained.

What are the tax implications of health savings accounts?

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.

 

Health savings accounts and retirement

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.

Is an HSA right for your business and employees?

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.

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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.