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A health savings account (HSA) offers several benefits to your employees. These accounts are portable, meaning they can keep them even if they leave your company. Plus, employees can use the accounts like savings accounts, allowing them to cover qualified healthcare expenses while generating interest on the money saved in the HSA.
With such obvious advantages, it seems the decision to add HSAs to your benefits package is a simple one. What isn’t so simple, however, is the decision to contribute to HSAs on behalf of your employees. Is it worth your time to do so? Is it even possible?
In this article, we answer those questions and more as we take a deep dive into HSAs and what HSA ER contributions mean for your business and its employees.
HSAs are personal savings accounts that are tied to qualified healthcare plans. For an employee to be eligible for an HSA, they must be enrolled in a high-deductible health plan (HDHP). The HSA then allows them to contribute income to their account, which they can use to cover qualified out-of-pocket expenses related to their HDHP.
All contributions an employee makes to their HSA come from pre-tax dollars. As such, employees pay no income tax on the money in their HSA. However, these tax benefits come with some strings attached. Employees generally have to pay income taxes and a 20% penalty if they withdraw funds from an HSA for a non-qualified reason before they turn 65. Being tied into an HDHP may also be a bad idea if the employee has access to more flexible health insurance options.
Employers can contribute to HSAs at their own discretion. This means you don’t have to contribute if you don’t want to, though nothing stops you from doing so. As a result, companies can use an employer-funded HSA as a key part of their benefits package.
Offering employer contributions also makes enrollment into the HDHP plan associated with the HSA more appealing. Though employees may have reservations about your company’s HDHP plan, you can often overcome these reservations by offering full or partial contributions to an HSA.
There are two ways for an employer to contribute to an employee’s HSA:
Also known as a “Cafeteria” plan, a Section 125 plan allows employees to put a portion of their pre-tax income toward qualifying expenses. HSA contributions are included. Employers can contribute by ensuring contributions are made from payroll before an employee’s income is taxed. An employer’s contributions can often be combined with an employee’s before sending them to the HSA, creating a more efficient process.
Note that any contributions your company makes are subject to Section 125 nondiscrimination rules. These generally ensure that no employees receive favorable treatment, such as employers making larger contributions for key employees and lower contributions for others.
You can make HSA ER contributions without having a Section 125 plan. In this case, the nondiscrimination rules applied to Section 125 don’t apply. But that doesn’t mean you don’t have to ensure comparability in contributions. Any funding offered must meet the employer contribution to HSA rules found in IRS Publication 969.
These comparability rules ensure employers contribute either the same dollar amount per employee or the same percentage of each employee’s HDHP deductible. The rules apply to all employees of the same employment type. As such, the rules that apply to one full-time employee apply to all of them. The same goes for part-time employees. You can’t contribute $100 to one part-time employee and $50 to another, for example. All must have equal contributions based on their employment type.
Failure to comply with these rules incurs a harsh penalty in the form of a 35% tax on all employer-funded HSA contributions.
An HSA allows your employees to benefit from tax-free employer contributions. HSA plans involve the use of pre-tax income, though it’s important to note that the meaning of this varies depending on where the money comes from.
With the right execution, no payroll or income tax is paid on the contribution. However, some situations make HSA employer contributions taxable. To understand what they are, you first need to know the difference between payroll and income tax.
Payroll taxes are used to fund various social programs, such as Medicare, unemployment insurance, and Social Security. They’re paid partially by the employer and partially by the employee. Income tax is applied to the employee’s salary and is paid entirely by them. It’s usually denoted on a W-2 as either “federal tax” or “withholding.” Employees typically have to pay both federal and state income taxes on their salaries.
Understanding these differences is important because they help provide a better answer to the question are employer HSA contributions taxable? The answer depends on how the contributions are made.
This is the most common way for employers to make contributions to an HSA. As mentioned previously, employers can make pre-tax contributions from an employee’s salary, with their permission. They can also make contributions directly on their employees’ behalf. In both cases, these are considered salary deductions.
Salary deductions mean the employee doesn’t have to pay income or payroll tax on the contribution.
There are several reasons why contributions may be made to an HSA outside of your company’s payroll system. The previously-mentioned method of contributing without a Section 125 plan often counts because the money contributed is considered part of an employee’s income. This is the reason why most employers create Section 125 plans alongside offering HSAs.
Contributions may also be made outside of payroll if an employee has their own HDHP coverage or if they choose to seek coverage away from their employer. In both cases, employees and employers can still contribute to these accounts.
Sadly, contributions made in this way are still subject to payroll tax. The good news is that your employees still don’t have to pay income tax on these contributions.
So, we can see that there isn’t an easy answer to the question of are employer HSA contributions pre-tax. It depends on the system used to contribute to the HSA and whether the employee links their HSA with the employer’s HDHP policy or their own.
Both employee and employer contributions to an HSA have to be reported on an employee’s W-2. This reporting involves completing Box 12 in Code W.
For example, let’s assume an employee contributes $1,000 to their HSA via an employer’s Section 125 plan. The employer matches that $1,000 contribution directly. In this case, the employee’s W-2 needs to show a $2,000 combined contribution inside Code W. Failure to complete the W-2 correctly can lead to several penalties:
To make matters worse, these penalties are often doubled in practice. They apply for incorrectly filing the W-2 with your employee and with the IRS. A company that incorrectly files a W-2 but fixes it within 30 days will likely have to pay a $100 penalty.
Furthermore, companies that file at least 250 W-2 forms have to pay a cost of coverage fee under the Affordable Care Act (ACA). This fee varies depending on the number of forms you submit and is detailed in Box 12 using Code DD of the W-2 form.
If your company decides to make employer-funded contributions to an HSA, it has to work within the contribution limits placed on these accounts.
A self-only plan, which just covers the employee who has the HSA, is limited to $3,650 per year. Family plans increase this contribution threshold to $7,300. You have the option of contributing more to the HSA if you want. However, any money paid into an HSA beyond these limits isn’t tax-deductible. Employees also have to pay a 6% excise tax on any money over the maximum limits.
Employees have the option to remove excess contributions before their taxes are filed. This helps them avoid the 6% excise tax, though they’ll still have to pay income tax because the removed money becomes part of their income. In some cases, an employee may choose to leave the excess in their HSA if the interest it generates proves advantageous. But the combination of income taxes and the excise tax makes this unlikely.
You now know that it’s possible to offer employer-funded HSA benefits. Accounting for HSA employer contributions is vital for the correct filing of W-2 forms and to ensure employees pay the appropriate amount of tax on contributions.
The next question is whether contributing to employee HSAs is worth it. To find out, we need to compare employer vs. employee HSA contributions, coupled with the pros and cons of each from the employer’s perspective.
While there are several reasons an employer may contribute to an HSA, there are also drawbacks to consider.
What if you decide not to help employees find their HSAs? There are positives and negatives to this decision too.
The decision to offer employer funding for HSAs comes down to your company’s circumstances.
On the one hand, offering an employer-funded HSA means you can provide more benefits to your employees. They’re happier because their employer helps them cover some out-of-pocket medical expenses. Plus, the nature of HSAs means employees can use them to build nest eggs for retirement due to the saving component. Your contributions help to set them up for the future, in addition to preparing them for unexpected emergencies in the present.
On the other hand, there’s no escaping the fact that making contributions to HSAs costs your company money. If your business operates on thin margins or you simply don’t want to incur the cost of employer funding, paying money into HSAs may be the wrong choice. You lose the ability to offer a key benefit but you might save your organization thousands of dollars per year, especially when taking potential W-2 penalties into account.
All of this means you have a decision to make. At Taylor Benefits Insurance Agency, we specialize in helping companies create attractive benefits packages. Our advisors and brokers can help you to determine if employer-funded HSAs are right for your company and help you to set this benefit up. To find out more, call us at 800-903-6066 or contact us online to get a free proposal.
Todd Taylor oversees most of the marketing and client administration for the agency with help of an incredible team. Todd is a seasoned benefits insurance broker with over 35 years of industry experience. As the Founder and CEO of Taylor Benefits Insurance Agency, Inc., he provides strategic consultations and high-quality support to ensure his clients’ competitive position in the market.
Todd Taylor with Taylor Benefits gives our small business the kind of personal service we need. Insurance benefits are important to our employees and Todd helps us find a balance between benefits and value. Todd responds immediately to my phone calls & e-mails. He has even gotten in touch with me on a Sunday when we were in need of coverage answers immediately. We are very pleased with the hands-on service Todd and his staff provide.”
-Ken and Linda Orvick, Orvick Management Group, Inc.
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