A health savings account (HSA) is an employee-owned bank account which allows employees to pay for current out-of-pocket expenses or save for future 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). Since the bank account is owned by the employee, the employee keeps the HSA even after employment ends. Keller Benefit Services specializes in the design, implementation, and communication of qualified HDHPs with HSAs.
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 IRS requirements in order for a health plan to be a qualified HDHP:
- Minimum deductible ($1,300 individual/$2,600 family in 2016)
- Maximum out-of-pocket (OOP) limit ($6,550 individual/$13,100 family in 2016)
- If enrolled in family coverage, the full family maximum OOP must be met before claims are paid 100% by the plan, even if only one family member has expenses.
- Starting in 2016, for the first time ever, if the family level coverage has a maximum OOP higher than $6,850, there will be an embedded individual maximum OOP of $6,850. Once any covered family member reaches $6,850 in claims, 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.
- Virtually all expenses, including prescription drugs, are subject to the deductible.
- Preventive services, such as well child care and routine cancer screenings, are the only benefits not subject to the deductible.
- If enrolled in family coverage, the full family deductible must be met before any expenses are paid by the HDHP, even if only one family member has expenses.
Employees cannot be enrolled in any other non-HDHP health coverage in order to make or receive HSA contributions. Other non-HDHP health 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 “HSA-compatible” coverage only. Enrollment in certain other benefits, such as disability, dental care, and 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 health plan.
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). However, if HSA funds are used for non-medical expenses, the distribution is taxable to the employee plus a 20% penalty (however, the penalty is waived if the employee is age 65 or older).
HSA Contribution Limits
For 2016, the IRS annual HSA contribution limits are $3,350 ($279.16 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 (2016), 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.
If an employee is enrolled in Medicare, he or she can no longer make tax-advantaged HSA contributions. If an employee elects to receive Social Security benefits, enrollment in Medicare Part A may be automatic and required at age 65.
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 taxed 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 a checking account funds, such as by checks, debit card, and online bill pay (as available by HSA bank, fees may apply). 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 do not file receipts to use their HSA funds. Employees 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 HSA is an employee-owned bank account. 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 if an employee’s HSA contributions exceed the monthly IRS limit times 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. Employees are allowed to contribute up to the annual IRS limit, even though not enrolled in the HDHP for the full year, as long as the employee is enrolled in an HDHP on December 1st and stays enrolled through December 31st of the following year. Otherwise, the employee will be taxed 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.