A health savings account (HSA) is an individually-owned bank account which allows employees to save for out-of-pocket medical expenses on a tax-advantaged basis.
Both the employer and the employee may contribute into the HSA bank account as long as the employee is enrolled in a qualified high deductible health plan (HDHP).
Employee Eligibility for HSAs
Employees must be enrolled in a qualified high deductible health plan (HDHP) in order to make or receive HSA contributions. There are several key provisions for a health plan to be a qualified HDHP:
- The plan must have a minimum deductible set by the IRS and indexed annually. For 2017, the minimum deductible is $1,300 for single coverage and $2,600 for family coverage.
- The plan must have a maximum out-of-pocket (OOP) limit set by the IRS and indexed annually. For 2017, the maximum OOP for is $6,550 for single coverage and $13,100 for family coverage.
- The majority of expenses, including prescription drugs, must be subject to the deductible. Preventive services, such as well-child care and routine cancer screenings, are the only covered expenses not subject to the deductible.
- If you are enrolled in family coverage, in general, the family deductible must be met before any expenses are eligible for reimbursement, and the family out-of-pocket limit must be met before the plan must pay 100% of eligible expenses, even if only one family member has expenses.
- However, if the family coverage has a maximum OOP that is higher than the ACA allowed individual OOP limit of $7,150, there will be an embedded individual maximum OOP of $7,150. Once any covered family member reaches $7,150 in OOP expenses, any further claims for that individual must be paid 100% by the plan. The rest of the family will continue to incur claims until the full family level maximum OOP has been reached.
Employees cannot be enrolled in any other non-HDHP coverage in order to make or receive HSA contributions. Other non-HDHP coverage includes a health care flexible spending account (FSA), Medicare, TRICARE, or a spouse’s employer’s non-HDHP plan. The employee must be excluded from all health care FSA coverage or have limited purpose health FSA coverage.
Enrollment in certain other health plans, such as disability and stand-alone dental/vision care, does not impact an employee’s ability to make or receive HSA contributions.
An employee’s spouse and children may be covered by both the employee’s HDHP and another non-HDHP plan. If the employee's family members are enrolled in the HDHP, the employee can contribution up to the family HSA limit even if the family members have non-HDHP coverage.
Tax Advantages of an HSA
In general, HSA contributions are tax-free as long as the employee was enrolled in a qualified HDHP at the time contributions were made. Both employers and employees can make tax-advantaged contributions to an employee’s HSA.
HSA funds can accumulate interest or investment earnings on a tax-free basis.
Employees may use HSA funds on a tax-free basis for qualified medical expenses incurred by themselves, their spouse, and tax dependents (even if they are not enrolled in the HDHP). Note that if HSA funds are used for non-medical expenses, the distribution is taxable to the employee plus a 20% penalty (the penalty is waived if the employee is age 65 or older).
HSA Contribution Limits
For 2017, the IRS annual HSA contribution limits are $3,400 ($283.33 per month) for single HDHP coverage and $6,750 ($562.50 per month) for family HDHP coverage. All funds deposited into the HSA, including any employee and employer contributions, apply towards the annual contribution limit.
Employees age 55 and older may make a catch-up contribution of $1,000, in addition to the above limits. An employee can only make one catch-up contribution per HSA. If the employee and spouse are both age 55 and older, the spouse may also make a catch-up contribution to his or her own HSA account, if eligible. However, if either spouse has family coverage, then the combined contributions of the spouses (before additional catch-up amounts) cannot be more than the family HSA contribution limit.
Employees cannot make tax-advantaged HSA contributions if enrolled in any non-HDHP coverage, including Medicare Part A. If an employee applies for Social Security benefits, enrollment in Medicare Part A is automatic at age 65 (or older). When enrolling in Medicare Part A after age 65, the effective date of Part A coverage can be retroactive up to 6 months prior to the application date.
How Employees Make HSA Contributions
Employees may make pre-tax HSA contributions through payroll deductions, if the employer offers a cafeteria plan. Unlike cafeteria plan restrictions on other pre-tax elections, an employee may change HSA payroll deductions at any time. Employees may also make contributions by directly depositing after-tax money into an HSA and deducting the contribution, up to IRS limits, on their federal income tax return.
Self-employed individuals, including 2% shareholders of an S-corporation, sole proprietors, and certain partners in a partnership, are not eligible to make pre-tax HSA contributions through payroll nor are they eligible for tax-free employer HSA contributions. Self-employed individuals may make or receive after-tax HSA contributions and then deduct the contribution on their federal income tax return.
How Employees Use HSA Funds
Employees can use their HSA funds on a tax-free basis to pay for qualified medical expenses even if they are no longer enrolled in a qualified HDHP. (Enrollment in a qualified HDHP is only required for the employee to make or receive HSA contributions, not to use the funds already in the HSA.)
Employees can access their HSA funds similarly to accessing checking account funds. Options for paying for out of pocket medical expenses include:
- Pay providers directly with HSA funds (via check, debit card, or online bill pay, as available)
- Pay with non-HSA funds, and then reimburse themselves with HSA funds
- Pay with non-HSA funds, and leave HSA funds to accumulate for future expenses
Employees may need to initially pay out-of-pocket for expenses that exceed their current HSA account balance. Once the HSA account balance is sufficient, the employee could reimburse themselves with the available HSA funds. Employees cannot use HSA funds for expenses incurred before the account was established.
Employees do not file receipts to use their HSA funds; they are responsible for retaining receipts as proof of medical expenses in case requested by the IRS.
Qualified Medical Expenses
Federal tax code defines “qualified medical expenses” in IRC Section 223. IRS Publication 502 provides a general guide as to what expenses may be qualified, but should be used with caution since the differences between tax deductible expenses versus HSA qualified medical expenses are not discussed in the Publication.
Expenses that satisfy the deductible of the qualified HDHP plan are generally qualified medical expenses. Although included in Publication 502, health insurance premiums are not qualified medical expenses, unless the premiums are for (a) long term care insurance, (b) COBRA coverage, (c) Medicare premiums other than Medigap, or (d) health care coverage while receiving unemployment benefits.
Loss of Eligibility for Employer Health Coverage
The employee retains ownership of the HSA and all accumulated funds, even if he/she loses eligibility for health coverage or terminates employment. However, individuals can no longer make tax-advantaged HSA contributions unless they remain covered by an HDHP, either through COBRA or another qualified HDHP.
A portion of HSA contributions will be taxed, and may be subject to an excise tax, if the contributions to an employee’s HSA exceed the monthly IRS limit for the number of months covered by the HDHP.
Establishing an HSA During the Calendar Year
Employees who become eligible for the HDHP mid-calendar year may establish an HSA but may only contribute up to the monthly IRS limit for each month enrolled in the HDHP.
However, if an employee is enrolled in an HDHP on December 1st and stays enrolled through December 31st of the following year, the employee is allowed to contribute up to the annual IRS limit, even though not enrolled in the HDHP for the full year. Otherwise, the employee will be taxed, and may be subject to an excise tax, on any contributions in excess of the monthly IRS limit times the number of months enrolled in the HDHP.
Tax Reporting Requirements
The employer will report the employee’s pre-tax payroll contributions and any tax-free employer contributions in Box 12 on the employee’s Form W-2.
The HSA banking institution will report any distributions on Form 1099-SA and any contributions on Form 5498-SA.
Employees must file Form 8889 “Health Savings Accounts” with their federal income tax returns.