What Employers Should Know about Health Savings Accounts
August 7, 2024
Rushton Accounting & Business Advisors
Health Savings Accounts (HSAs) are a tax-smart way to cover an individual's uninsured medical expenses, as well as certain other out-of-pocket medical, dental, vision, hearing, long-term care expenses and insurance premiums. Your business can set up HSAs for qualifying employees. Then the business can fully or partially fund the accounts or let employees fund them with salary-reduction contributions.
From a practical standpoint, it may be too late to add HSAs to your benefits package for this year, but next year is right around the corner. Here's what you need to know about employer-sponsored HSAs.
The Basics
Under the Affordable Care Act, health insurance plans are categorized as Bronze, Silver, Gold or Platinum. Bronze plans have the highest deductibles and least-generous coverage, so they're the most affordable.
Employees covered by qualifying high-deductible health plans (HDHPs) — generally equivalent to Bronze plans in terms of deductibles and coverage — are eligible for tax-favored HSA contributions made by your company, the employees themselves with salary-reduction contributions, or a combination of both.
This set-up offers four key tax benefits:
1. The employer can deduct any HSA contributions made to employee accounts.
2. Employer-paid contributions are tax-free to recipient employees.
3. Employees can subtract any contributions they make from their taxable salaries, which equates to a tax deduction.
4. HSA withdrawals taken by employees to cover qualified medical expenses are tax-free.
An HSA is an IRA-like trust or custodial account that can be set up at a bank, insurance company or any other entity that the IRS decides is suitable (such as a brokerage firm). It is intended to be used for the purpose of paying the account owner's (employee's) qualified medical expenses. These include uninsured costs incurred by the employee, as well as his or her spouse and dependents.
In theory, HSAs can offer the same investment options as IRAs. However, some HSA trustees may limit investment choices to more-conservative options to protect these accounts from market volatility.
Qualifying Coverage
To be eligible for HSA contributions made by the employer or the employee, the employee must be covered by a qualifying HDHP and have no other general health coverage. Premiums for qualifying coverage can be paid by the company, the employee or partly by both.
For 2024, a qualifying high-deductible policy is defined as one with a deductible of at least $1,600 for self-only coverage or $3,200 for family coverage. (For 2023 these figures are $1,500 and $3,000 respectively.)
For 2024, qualifying policies can have out-of-pocket maximums of up to $8,050 for self-only coverage or $16,100 for family coverage. (For 2023 these figures are $7,500 and $15,000 respectively.)
Important: For HSA eligibility purposes, HDHP premiums paid by an employee don't count as out-of-pocket medical costs.
Contributions
For the 2024 tax year, a tax-favored HSA contribution of up to $4,150 can be made by or for an employee who has qualifying self-only coverage, or up to $8,300 for an employee who has qualifying family coverage (anything other than self-only coverage). If an employee is age 55 or older as of year-end, he or she can contribute an additional $1,000. (For 2023 these HSA figures are $3,850 and $7,750 respectively.)
HSA contributions made by an employee can be done through salary-reduction contributions to his or her company's Section 125 cafeteria benefit plan. Employer-paid contributions can be made directly to employee accounts.
Important: Eligibility for making HSA contributions doesn't depend on the employee's level of income. Everyone who's covered by a qualifying HDHP can have an HSA and enjoy the tax benefits.
Distributions
HSA distributions used to pay qualified medical expenses of the HSA owner (the employee) and his or her spouse or dependents are federal-income-tax-free. You also can build up a balance in the account if contributions, plus earnings, exceed withdrawals for medical expenses. Any earnings are federal-income-tax-free.
So, if you're in good health and take minimal or no withdrawals, you can use an HSA to build up a substantial medical expense reserve fund over the years while earning tax-free income.
If you still have an HSA balance after reaching Medicare eligibility age (generally age 65), you can drain the account for any reason without a tax penalty. If you don't use the withdrawal to cover qualified medical expenses, you'll owe federal income tax and possibly state income tax, but the 20% tax penalty that generally applies to withdrawals not used for medical expenses won't apply. And there's no tax penalty on withdrawals after disability or death.
Alternatively, you can use your HSA balance to pay uninsured medical expenses incurred after reaching Medicare eligibility age. If your HSA still has a balance when you die, your surviving spouse can take over the account tax-free and treat it as his or her own HSA — provided your surviving spouse is named as the account beneficiary. In other cases, the date-of-death HSA balance must generally be included in taxable income on that date by the person who inherits the account.
Important: HSA funds can't be used to make tax-free reimbursements for medical expenses that were incurred before the account was opened.
Employer-Funded Accounts
Employers can make deductible contributions to HSAs set up for their employees. Employer contributions are subject to the same dollar limits and eligibility rules as employee contributions. For 2024, the limits are $4,150 for employees with qualifying self-only coverage or $8,300 for employees with qualifying family coverage (increased by $1,000 for people age 55 or older). For 2023 the limits are $3,850 and $7,750 respectively.
Employer-paid contributions are exempt from federal income tax, as well as Social Security, Medicare and FUTA taxes. That's because these contributions are considered to be for an accident or health plan. Avoiding the employer portion of federal employment taxes is a plus for your business.
However, your company may face a 35% federal excise tax if comparable contributions aren't made on behalf of all employees with comparable coverage during the same period. For this purpose, "comparable contribution" means the same amount or the same percentage of the health plan deductible. The comparability rule is applied separately to part-time employees who customarily work less than 30 hours per week.
An exception to the comparable contribution requirement allows employers to make larger HSA contributions for non-highly compensated employees than for highly compensated employees without incurring a penalty.
Right for Your Business?
HSAs go hand in hand with more-affordable qualifying HDHPs. Plus, HSAs offer tax advantages to employers and employees. So, adding HSAs to your benefits options can be a win-win situation. Contact your financial advisor for more information. He or she can help you fill out the requisite forms and maintain adequate records if your business decides to pursue this alternative.
Rushton provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
