By Fennemore’s Ryan C. Curtis and Kristi Hill
The Great Resignation is causing employers to look closely at benefits they provide so they can be in the best position to attract and retain a quality work force. Health Savings Accounts (HSAs) are often an overlooked benefit. HSAs, which are popular with employers and employees, also offer 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 enrolled in a high deductible health plan 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. 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 as they are incurred. In 2021, employees may defer up to $3,600 (individual) or $7,200 (family) per year. In 2022, these limits will increase respectively to $3,650 and $7,300. Lower-income employees may be more hesitant to defer a 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 paying for the same medical expenses using after-tax money already reduced by income and payroll taxes. Employers can help employees better understand such advantages and can help increase participation and deferral amounts by matching a portion of employees’ HSA deferrals.
- Another HSA strategy is to build a personal medical expense “safety net.” HSAs are allowed when paired with high-deductible health plans, which have lower monthly employee premiums. Employees can struggle to access plan benefits if unable to meet the high deductible, but a well-funded HSA can help cover that gap. With careful planning, an employee could set aside a reserve sufficient to cover the full deductible amount in a few years. Even if the full deductible is not set aside, a good HSA balance can help employees get through unexpected medical expenses.
- Finally, an increasingly popular approach is to treat an HSA as supplemental retirement savings. Income deferrals to 401(k) retirement plans in 2021 are limited to $19,500, with an additional catch-up deferral of $6,500 for those age 50 and up (the limits for 2022 will be announced soon). The maximum annual deferral to a 401(k) can be supplemented by deferring additional amounts 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. A retired individual who enjoys good health can always withdraw funds beginning at age 65 for non-medical expenses subject to regular income tax, similar to a 401(k) account.
The advantages HSAs offer are significant and are likely to increase in coming years. Various healthcare reform proposals in recent years sought to increase the annual HSA contribution limits and expand what constitutes qualified medical expenses. Employers and employees benefit when employers help employees understand these alternatives and when employers encourage participation through tax-deductible employer contributions.
How can we help your organization thrive? Fennemore’s ERISA team has extensive experience counseling employers on all aspects of employee benefits.
For more information, please visit: https://www.fennemorelaw.com/services/practices/erisa-and-employee-benefits