Employers struggling to provide meaningful benefits to attract, retain and assist their employees can look to Health Savings Accounts. This year has been filled with uncertainty regarding the Affordable Care Act, and repeal and replace efforts, but HSAs have a bright future with all the recent healthcare reform proposals looking to expand their use. HSAs are popular with employers and employees who enjoy significant tax advantages. But taking full advantage of the benefits HSAs offer to employers and employees requires a better understanding of how they work, rethinking how they are used, and communicating such benefits more effectively to employees.
An HSA gives an employee a triple tax benefit. Employees may contribute pre-tax money to an HSA to reduce their taxable income, invest and grow that money tax free, and withdraw such money at a later time, also tax-free if used for qualified medical expenses. Plus, at age 65, an individual can withdraw money without penalty for any purpose, subject to ordinary income tax if not used for qualified medical expenses. HSAs can even be used for self-reimbursement for medical expenses previously incurred. Employers appreciate HSAs because they provide an additional benefit to employees, and any contributions employers make to an employee’s HSA are tax-deductible to the employer. These advantages are attractive, and individuals can use and benefit from them in multiple ways.
The most obvious HSA use is as a revolving account to pay for qualified medical expenses. Employees may currently defer up to $3,400 (individual) or $6,750 (family) per year. Younger and lower-income employees may be hesitant to defer any portion of their income, but the tax savings may be most important for those same employees. Using $100 pre-tax for medical expenses makes money go farther than using the same $100 after paying all applicable taxes. Reducing that $100 by the income and payroll taxes (FICA and Medicare) an employee would normally pay demonstrates the significant savings. Employer communications can help employees understand such advantages. Employers can also help increase participation and deferral amounts by matching a portion of employees’ HSA deferrals or by providing an initial “seed” contribution for employees who open an HSA. Both are tax-deductible to the employer. Employers should consult with qualified legal counsel regarding matching rules.
Another HSA strategy is to build a personal medical expense safety net. HSAs are permitted when paired with high-deductible health plans, which have lower monthly employee premiums, but employees can struggle to access plan benefits if unable to meet the high deductible. Saving through an HSA can help cover that gap. An employee deferring the maximum amount to an HSA, and not using it, could set aside a reserve sufficient to cover the full deductible amount in a few years. This is not easy for lower-wage earners or for those who have significant, ongoing medical expenses, but even if the full deductible is not set aside, a good HSA balance can still help employees get through unexpected medical expenses. Employers can provide guidance in this respect — especially as more employers switch from traditional to high-deductible plans. An employee who has a reduced monthly premium when switching to a high-deductible plan could use that savings to grow a meaningful HSA balance.
An increasingly popular approach is to treat an HSA as supplemental retirement savings. Income deferrals to 401(k) retirement plans in 2017 are limited to $18,000, with an additional catch-up deferral of $6,000 for those age 50 and up. This maximum annual deferral to a 401(k) can be supplemented by deferring an additional $6,750 per year (for a family) to an HSA. Balances in an HSA can typically be invested like a 401(k) account. Unlike a 401(k) account, however, HSA amounts can be used at any time for qualified medical expenses as needed without penalty or taxes. A sizable HSA can be especially beneficial during retirement, when individuals can expect to have increased medical expenses. Finally, a retired individual who enjoys good health can always withdraw funds beginning at age 65 for non-medical expenses subject to regular income tax. Even better, that person may be able to self-reimburse for medical expenses paid years before with non-HSA funds.
The advantages HSAs offer are significant and are likely to increase in coming years. The various healthcare reform proposals of 2017 sought to increase the annual HSA contribution limits, expand what constitutes “qualified medical expenses,” and reduce penalties for early withdrawals. Employers and employees benefit when employers help employees understand these alternatives and when employers encourage participation through tax-deductible employer contributions.
Ryan Curtis is an of counsel attorney with Fennemore Craig, PC, where he assists employee benefit plans, trustees and administrators in complying with important federal laws, including ERISA and the Affordable Care Act. He has an ERISA litigation background and has successfully defended plan sponsors in IRS audits and Department of Labor investigations.
Kristi Lundstrom is an associate attorney with Fennemore Craig, PC, where she helps employers establish and maintain their employee benefit plans, including with respect to complicated plan corrections. She regularly represents plans and plan sponsors in front of regulating government agencies, particularly the IRS.
