Time to Take Another Look at Health Savings Accounts
Pandemic-related financial pressure is forcing some businesses to take a long, hard look at their health insurance plans and other benefits offered to employees. One practical solution has been gaining traction: the introduction of Health Savings Accounts (HSAs) by companies that haven't historically offered them.
HSAs have been called “medical IRAs” because they operate much like traditional IRAs. But there are several important differences.
Help with High-Deductible Health Plans
Typically, employers offer HSAs in conjunction with high-deductible health plans (HDHPs). (However, individuals may set up HSAs on their own.) To participate, employees must be enrolled in an HDHP, have no other insurance, and be ineligible for Medicare. The IRS sets the standards for meeting the thresholds for HDHPs, subject to inflation indexing.
Contributions may be made by the employee, the employer, or both. Employer contributions made on an employee's behalf are tax-deductible by the employer. Employee contributions to HSAs are limited. For 2021, it's $3,600 for an employee or $7,200 for family coverage. Those age 55 and older can make additional “catch-up contributions” of $1,000.
Participants are able to withdraw amounts for qualified out-of-pocket expenses, such as physician and dentist visits, without tax consequences. HSAs may be used to cover co-pays and deductibles. But they generally can't be used to pay insurance premiums.
HSAs provide several key advantages. For example:
- For participants, contributions are tax-deductible or are made on a pre-tax basis through an automatic payroll deduction.
- Any earnings within an HSA account are tax-free for participants.
- Withdrawals used to cover qualified medical expenses aren't subject to tax. The list of qualified expenses is extensive and ranges from eyeglasses to root canals to fertility treatment drugs.
- Participants can use their HSA to pay for expenses even after they've retired. There's no time limit for withdrawals.
- HSAs are portable, so participants can continue to use their HSAs if they change jobs or insurance carriers.
- Although participants and their employers generally make most of the contributions to HSAs, family members and others also may contribute.
- HSA funds may be invested in a wide range of securities, including mutual funds, stocks, and bonds.
- Money remaining in an HSA at the end of the year is rolled over to the next year.
Rollovers provide a distinct advantage to HSAs over flexible spending accounts (FSAs). Any unused balance in an FSA at year's end may be subject to a limited carryover, but in most cases, balances are forfeited.
A Few Drawbacks
HSAs also have some drawbacks. For example, HSAs are available only to employees enrolled in HDHPs. And participants can use HSA funds only for healthcare expenses. If funds are used for nonqualified expenses, the account withdrawal will be subject to tax. What's more, the IRS will tack on a 20% penalty if the account holder is younger than age 65. Compare this to a 10% tax penalty for early withdrawals from traditional IRAs before age 59½.
Expenses are another potential concern. In some cases, HSA providers charge monthly account fees or transaction fees. Also, participants could be subject to extra charges for account overdrafts or deposits that don't clear their banks.
Finally, beneficiaries may not share the original participant's tax advantages. If an HSA participant dies, account funds are made available without tax liability to a spouse beneficiary who assumes the account as his or her own. But for other beneficiaries, the account will no longer be treated as an HSA and is subject to tax.
Embraced by Employees
Employees generally welcome an HSA option. If your organization is trying to cut costs by switching to an HDHP, consider offering an HSA at the same time.