With unemployment at record lows — both here in Maine and across the nation — retaining and attracting employees is a high priority for many business owners. So as the year winds down and you look ahead to 2020, one way you can address this issue is by improving your employee benefits, which may include adding Health Savings Accounts (HSAs).
HSAs are a tax-smart way to cover an individual’s uninsured medical expenses, as well as certain other out-of-pocket medical, dental, vision, hearing, long-term care expenses and insurance premiums. Your business can set up HSAs for qualifying employees. Then the business can fully or partially fund the accounts or let employees fund them with salary-reduction contributions.
Here’s how HSAs work.
Under the Affordable Care Act, health insurance plans fall into one of four categories: Bronze, Silver, Gold or Platinum. Generally, most Bronze plans are considered high-deductible health plans (HDHPs), which makes them eligible for tax-favored HSA contributions. These contributions are made by your company, the employees themselves with salary-reduction contributions, or a combination of both. There are four major tax benefits to these HSA contributions:
- Employers can deduct any HSA contributions made to employee accounts.
- Employer-paid contributions are tax-free to recipient employees.
- Employees can subtract any contributions they make from their taxable salaries, which equates to a tax deduction.
- HSA withdrawals taken by employees to cover qualified medical expenses are tax-free.
HSA contributions can be used to pay the account owner’s (employee’s) qualified medical expenses. These include uninsured costs incurred by the employee, as well as his or her spouse and dependents.
How to Set Up an HSA
HSAs are similar to IRA-like trusts that can be set up at a bank, an insurance company or any other IRS-approved entity (such as a brokerage firm).
In theory, HSAs can offer the same investment options as IRAs. However, some HSA trustees may limit investment choices to more-conservative options to protect these accounts from market volatility.
Employees must be covered by an HDHP to be eligible for HSA contributions, though it doesn’t matter if the premium is paid by the company, the employee or partly by both. For 2020, an HDHP is defined as one with a deductible of at least a $1,400 for self-only coverage or $2,800 for family coverage. These qualifying policies can have out-of-pocket maximums of up to $6,900 for self-only coverage or $13,800 for family coverage.
Important: For HSA eligibility purposes, HDHP premiums paid by an employee don’t count as out-of-pocket medical costs.
For the 2020 tax year, a tax-favored HSA contribution of up to $3,550 can be made by or for an employee who has qualifying self-only coverage, or up to $7,100 for an employee who has qualifying family coverage (anything other than self-only coverage). If an employee is age 55 or older as of year end, these amounts increase by $1,000.
HSA contributions made by an employee can be done through salary-reduction contributions to his or her company’s Section 125 cafeteria benefit plan. Employer-paid contributions can be made directly to employee accounts.
Important: Eligibility for making HSA contributions doesn’t depend on the employee’s level of income. Everyone who’s covered by a qualifying HDHP can have an HSA and enjoy the tax benefits.
HSA distributions used to pay qualified medical expenses are federal-income-tax-free. Account owners can also build up a balance in the account if contributions, plus earnings, exceed withdrawals for medical expenses. Any earnings are federal-income-tax-free.
HSA account owners who still have a balance upon reaching Medicare eligibility (generally age 65) have two options:
- Drain the account for any reason. If the withdrawal isn’t used to cover qualified medical expenses, it’ll be subject to federal (and possibly state) income tax. However, the 20% tax penalty that generally applies to withdrawals not used for medical expenses won’t apply. And there’s no tax penalty on withdrawals after disability or death.
- Use the HSA balance to pay medical expenses not covered by Medicare. If the account owner has a balance upon death, spouse can take over the account tax-free and treat it as his or her own HSA — provided the surviving spouse is named as the account beneficiary.
Important: HSA funds can’t be used to make tax-free reimbursements for medical expenses that were incurred before the account was opened.
Employers can make deductible contributions to their employees HSAs set up for their employees. Employer contributions are subject to the same dollar limits and eligibility rules as employee contributions. They’re also exempt from federal income tax, as well as Social Security, Medicare and FUTA taxes because they’re considered to be for an accident or health plan.
Avoiding the employer portion of federal employment taxes is a plus for your business. However, your company may face a 35% federal excise tax if comparable contributions aren’t made on behalf of all employees with comparable coverage during the same period. For this purpose, “comparable contribution” means the same amount or the same percentage of the health plan deductible. This rule is applied separately to part-time employees who customarily work less than 30 hours per week.
An exception to the comparable contribution requirement allows employers to make larger HSA contributions for non-highly compensated employees than for highly compensated employees without incurring a penalty.
Right for Your Business?
HSAs go hand in hand with more-affordable qualifying HDHPs. Not only can they provide your business with certain tax advantages, they can help your employees save on their taxes and help pay for their medical expenses — which is a great benefit to offer your staff.