HSA Funding

As many of our blog posts do, today’s post originates from a question from one of our readers regarding funding an HSA. The question had to do with the tax treatment of contributions to the HSA and whether said contributions are free from FICA tax.

In order to have an HSA the employer/employee must be participating in a high deductible health plan (HDHP). HDHP plans must meet a minimum deductible of $1,300 for single individual plans and $2,600 for family plans. In addition, the maximum contribution for an HSA is $3,350 for an individual plan and $6,750 for a family plan. For those age 55 and older, the plans allow an additional $1,000 catch-up contribution.

Generally, employers making contributions to the employees’ HSA avoid paying FICA and FUTA taxes and are also allowed a corresponding tax deduction for providing the employee benefit.

Employees making contributions to their own HSA through a pre-tax payroll deduction plan avoid not only income taxation but also FICA taxes. Qualified distributions from the HSA are then tax free. This is one of the rare instances where the money is truly never taxed.

Employees with an HSA but not allowed to make pre-tax contributions through payroll deductions can still get some of the tax benefits. They are allowed to make contributions from after-tax dollars and then take the corresponding tax deduction for the contribution when they file their income taxes. However, the benefit of not paying FICA taxes is lost.

For many individuals, HSAs are becoming more common. Whether because their employers are trying to save on health insurance costs or the individuals rarely needs or seeks medical treatment, those with HSAs should consider funding them to take advantage of the tax savings.

HSAs allow money not used in a given year to be carried over to the next year. There is no “use it or lose it feature” like an FSA. Additionally, HSAs have been getting more attention regarding a potential way to help fund retirement. The reason is that currently HSAs carry a hefty tax penalty for amounts not used for qualified expenses. Non-qualified distributions from an HSA are taxed as ordinary income and are subject to a 20% penalty.

However, once an individual turns age 65 any non-qualified distributions from an HSA are subject to only ordinary income tax rates. The 20% penalty is gone. Qualified distributions are still tax-free. Individuals currently funding their 401(k) and IRA may consider maximizing their contributions to the HSA as well (assuming they have one). HSA money can generally be invested in a number of ways; from stock and bond mutual funds to a simple savings account. In addition to the tax savings on contributions, individuals also have advantages on distributions.