The Rise of HSAs
According to the U.S. Treasury, "Health Savings Accounts (HSAs) were created in 2003 so that individuals covered by high-deductible health plans could receive tax-preferred treatment of money saved for medical expenses." Since then, HSAs have grown in popularity in the workplace. One study found that 19 percent of workers were covered by a high-deductible health plan and HSA in 2016, up from 15 percent in 2015, and just 2 percent in 2006. What factors are contributing to this rise in HSAs?
HSAs have become an attractive employee benefit from both the employer and employee perspective. The only requirements for having an HSA are that the individual is covered by a high-deductible health plan (HDHP) and is not enrolled in Medicare. The IRS defines what constitutes an HDHP. The following chart shows the requirements for 2017 and 2018:
Type of Plan
An employer can play any role it chooses with respect to HSAs:
- Offer both HDHPs and HSAs. The cost to an employer for this arrangement usually is considerably less than the cost of paying for traditional health insurance for their staff. As long as an employee is covered by an HDHP for all of December and coverage continues for 12 months, a full-year contribution can be made for the first year. Thus, if a company starts an HDHP on December 1, 2017, a full-year contribution for 2017 is allowed; no proration is required.
- Offer HDHPs only. This then allows employees to make their own HSA contributions if they want to. They may deduct their contributions on their personal tax returns; no itemizing is required.
- Offer HDHPs and give employees the opportunity to make HSA contributions on a pre-tax basis. Employee contributions to their accounts through a payroll deduction plan are included in wages and are subject to FICA and FUTA taxes as well as income tax withholding. However, HSA contributions made under a salary reduction arrangement in a cafeteria plan are not treated as wages subject to employment taxes or withholding.
Whichever arrangement is chosen, employees are fully vested in their accounts immediately. And the accounts are portable, which means that employees take the accounts with them when they leave the company.
Triple tax advantage
HSAs are the one example in the tax law that provides triple tax benefits:
- Contributions are tax deductible. Contribution limits for 2017 are $3,400 for self-only coverage and $6,750 for family coverage. The limits for 2018 are $3,450 for self-only coverage and $6,900 for family coverage. An account owner can add another $1,000 if he or she is at least 55 years old by the end of the year.
- Earnings grow on a tax-deferred basis (i.e., no annual tax on earnings). Accounts with no maintenance fees and a good menu of investment options could benefit from investment returns over the long term.
- Distributions to pay qualified medical expenses are tax-free. It's up to the account owner (not the employer) to decide when to take distributions and maintain records on what the distributions were used for.
Employer contributions to HSAs as well as employee salary reduction contributions are not subject to FICA or FUTA taxes.
Retirement savings supplement
Those who stay healthy or use non-HSA funds to pay out-of-pocket medical costs can allow savings to build up in their accounts on a tax-deferred basis. Once the account owner reaches age 65, distributions can be taken for any reason without a tax penalty. Of course, distributions other than for qualified medical expenses are taxable to the same extent as a distribution from an IRA funded with fully deductible contributions.
Possible legislative changes
Health reform changes could make HSAs even more attractive. Some proposals under consideration include:
- Increasing the annual contribution limit to the amount of the out-of-pocket deductible required by an HDHP (currently, the deduction is considerably lower than what the individual could be out of pocket for the year under the HDHP).
- Expanding the definition of qualified expenses to include over-the-counter medications.
- Allowing married persons age 55 and older to each contribute an additional $1,000 to the same account (currently, each must have a separate account to do this).
- Lowering the penalty on non-medical distributions to 10 or 15 percent (the current penalty is 20 percent).
HSAs have a great deal to offer. Employers not currently offering these accounts should review their health coverage policies in view of HSA advantages. Those offering HSAs should review the terms of current accounts offerings to check for fees, investment choices, and investment performance so that changes can be made if necessary.