HSAs Decoded: The Pros, Cons and Practical Insights for Employers and Employees

Health Savings Accounts (HSAs) have evolved significantly since their inception over two decades ago. Initially perceived as a benefit that only executives would utilize, HSAs have become a mainstream tool for employees across all income levels. These accounts serve as a vital resource for managing healthcare costs and planning for future medical expenses, offering a range of advantages and disadvantages that employees and benefits administrators need to consider carefully.

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What are HSAs?

At its core, an HSA is a savings account designed to help individuals pay for qualified medical expenses. Contributions to HSAs can be made by individuals, employers, or others on behalf of individuals, provided they meet certain eligibility criteria, such as being enrolled in a high-deductible health plan (HDHP). HSAs provide tax-deferred growth, and distributions are tax-free when used for qualified medical expenses.

For 2024, the contribution limits for HSAs are $4,150 for individuals with self-only coverage and $8,300 for family coverage. These limits increase annually, and for 2025, they will rise to $4,300 and $8,550, respectively.

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Advantages of HSAs for Employees

1. Triple Tax-Advantaged Status: One of the key benefits of HSAs is their triple tax-advantaged status. Contributions made to an HSA are exempt from federal income tax, and the earnings on the account are tax-free. Finally, distributions from the account, if used for qualified medical expenses, are also tax-free. This is a highly efficient way to manage healthcare costs while reducing taxable income.

2. Portability: Unlike other health accounts like flexible spending accounts (FSAs), HSAs are entirely portable. The funds remain with the employee, regardless of employment changes or health plan alterations. This means that even if an employee leaves their job or switches to a non-HDHP, the HSA funds remain theirs to use for future qualified medical expenses.

3. Long-Term Savings for Retirement: HSAs also offer employees a strategic advantage when it comes to retirement planning. Employees can allow the funds in their HSA to grow tax-free, using them as a tax-advantaged savings vehicle for future medical expenses. Once an individual reaches the age of 65, they can use the funds for any purpose without incurring the 20% penalty (though non-medical expenses will still be subject to regular income tax).

4. No "Use-It-Or-Lose-It" Rule: Unlike FSAs, which come with the risk of forfeiting unused funds at the end of the year, HSAs have no such stipulation. Unused funds automatically roll over to the following year, making them a better option for employees who want to build a financial buffer for healthcare expenses.

5. Flexibility in Healthcare Spending: HSAs allow employees to use the funds as they see fit, as long as they are for qualified medical expenses. This includes a broad range of expenses, from prescription medications to dental care. This flexibility adds to the account’s appeal.

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Disadvantages of HSAs for Employees

1. High Deductible Requirement: The major downside of HSAs is the need for an HDHP, which typically requires individuals to meet a higher deductible before their insurance kicks in. In 2024, the deductible for self-only coverage is $1,600, while family coverage requires a deductible of $3,200. These figures increase to $1,650 and $3,300 in 2025. This higher upfront cost can discourage individuals from seeking care, especially preventive care, until they have met their deductible.

2. Risk of Medical Debt: While HSAs allow employees to save for medical expenses, the associated high deductibles can put employees at risk for accruing medical debt. The out-of-pocket cost before insurance coverage begins can be significant, which may deter individuals from seeking necessary treatment.

3. Record-Keeping Challenges: To fully take advantage of the tax benefits associated with an HSA, employees must maintain detailed records of their medical expenses. Failing to do so can result in complications if they are audited by the IRS. In addition, non-qualified withdrawals are subject to income tax and a 20% penalty if the individual is under the age of 65.

4. Complexity in Managing Contributions: Understanding and adhering to the contribution limits is crucial to avoid tax penalties. Employees must be diligent in ensuring that contributions do not exceed the annual limits, as excess contributions are subject to a 6% excise tax unless they are corrected.

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Advantages for Benefits Administrators

1. Simplified Administration: HSAs offer a simplified administrative process compared to FSAs. Since HSAs are not considered Employee Retirement Income Security Act (ERISA) employee welfare benefit plans, benefits administrators are not responsible for determining whether an expense is qualified. This responsibility falls on the HSA account owner.

2. Minimal Reporting Requirements: HSAs generally have minimal reporting requirements. Employers only need to report pre-tax deferrals to the HSA in Box 12 of the employee’s Form W-2, using Code W. The responsibility for reporting HSA distributions falls to the financial institution, not the employer, which can alleviate the administrative burden.

3. Revenue Opportunities for Non-Bank Trustees (NBT): In some cases, benefits administrators who attain non-bank trustee (NBT) status from the IRS may find additional revenue opportunities through HSAs. NBTs may be allowed to share in the interest earned on HSA cash balances, creating a potential income stream for the employer or administrator.

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Disadvantages for Benefits Administrators

1. IRS Reporting: While the reporting requirements are less extensive than other health plans, benefits administrators still need to ensure compliance with IRS regulations. Mistakes in reporting can lead to penalties and tax complications for both the employee and employer.

2. Difficulties in Correcting Errors: If errors are made in the administration of an HSA, they can be challenging to correct compared to other health accounts like FSAs. For instance, improperly categorized distributions or contributions can be difficult to unwind, potentially leading to IRS penalties or audits.

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Practical Considerations for Employers

For organizations evaluating the use of HSAs as part of their benefits package, the decision should align with their overall compensation strategy and employee needs. Here are a few key considerations:

1. Offering Seed Money: Employers can enhance the attractiveness of HSAs by providing seed money—an initial contribution to the employee's HSA. This helps employees manage the high deductibles associated with HDHPs, making the HSA option more viable, especially for lower-income employees.

2. Educating Employees on Usage: It's crucial for employers to provide education and resources to employees to ensure they understand how HSAs work. Many employees are not fully aware of the long-term savings potential of an HSA, and without proper guidance, they may not use the account to its full advantage.

3. Encouraging Preventive Care: To mitigate the risk of employees avoiding healthcare due to high deductibles, employers can offer programs that incentivize preventive care. For instance, employers can partner with healthcare providers to offer reduced costs for preventive services or include wellness programs that promote long-term health.

4. Integration with Retirement Planning: Employers should promote the HSA’s potential as a retirement savings vehicle, particularly for employees nearing retirement. Unlike 401(k)s, HSAs allow employees to pay for healthcare costs tax-free, which can be a significant advantage given rising healthcare costs in retirement.

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Is an HSA the Right Choice?

Health Savings Accounts can be a valuable tool for employees and employers alike, offering tax benefits, long-term savings opportunities, and flexibility in healthcare spending. However, they also come with risks, particularly the potential for accruing medical debt due to high deductibles. Employers must weigh the benefits and drawbacks when considering whether to offer HSAs as part of their benefits package.

For employees, understanding how to use an HSA effectively is key to maximizing its potential. Education, proper planning, and maintaining detailed records are essential to avoid the pitfalls of mismanagement and to fully reap the tax benefits of these accounts.

At Axis HR Solutions, we specialize in helping organizations design and implement benefits plans that align with their strategic goals. Whether you are considering adding an HSA option or looking to optimize your existing benefits offering, our team can provide expert guidance tailored to your needs. Visit our website at axishrky.com to learn more about how we can help you navigate the complexities of benefits administration and ensure your employees have access to the best tools for managing their healthcare and financial well-being.