What is an HSA and How Does it Work? 5 Things You Need to Know

Tired of high healthcare costs?

Rising healthcare expenses are frustrating for small businesses and employees alike. By not taking advantage of tax savings and investment opportunities from HSAs could cost tens of thousands of dollars for your business.

Learn the essentials of HSAs with 5 key insights. Explore what HSAs are, how they work, and why they're vital for managing health insurance and healthcare expenses. Get ready to unlock the benefits of an HSA.

What is an HSA, and How Does it Work?

First things first, what exactly is an HSA? We’ll dive into the details later in this post, but essentially, you can think of an HSA as a personal savings account dedicated to healthcare expenses.

As an employer, you can offer HSAs as part of your employee benefits package. Employees can then contribute a portion of their salary to their HSA account up to the annual contribution limit set by the IRS. These contributions are made pre-tax, reducing the employee's taxable income.

Any funds deposited into the HSA can be invested, like a retirement account, allowing the account balance to grow over time. Employees can then use the funds in their HSA to pay for qualified medical expenses, such as doctor visits, prescription medications, and even certain medical equipment.

Important Note: Unused funds in the HSA roll over from year to year, allowing employees to build up savings for future healthcare needs.

HSAs offer small businesses and their employees a valuable tool for managing healthcare expenses. By understanding what an HSA is and how it works with 125 Plans and more, you can harness its benefits to provide your employees with a tax-advantaged savings option for healthcare costs.

What is an HSA?

An HSA is a tax-advantaged account that allows individuals to set aside pre-tax dollars to pay for qualified medical expenses. HSAs are typically offered in conjunction with a high-deductible health insurance plan, and they provide a triple tax benefit:

Contributions are tax-deductible
Growth is tax-free
Withdrawals for qualified medical expenses are tax-free

These advantages make HSAs an attractive option for both employers and employees, as they provide a way to save money on healthcare costs while also enjoying potential tax savings.

You should work with a benefits specialist or tax advisor to set up your HSA, but here are the basic steps you should take to set up this solution for your employees:

Research and Understand HSA Requirements: Familiarize yourself with the eligibility criteria and requirements for setting up an HSA. Ensure that your business and employees meet the necessary criteria, such as having a high-deductible health plan.
Choose an HSA Provider: Research and select a reputable HSA provider or financial institution that offers HSA services. Consider fees, investment options, customer support, and user-friendly online platforms.
Communicate with Employees: Educate your employees about HSAs and the benefits they offer. Provide clear information about how HSAs work, the tax advantages, contribution limits, and the potential for investment growth.
Set Up Payroll Deductions: Work with your payroll provider or HR department to establish payroll deductions for HSA contributions. Determine the desired contribution amount and set up a system to deduct those amounts from employee paychecks regularly.
Educate Employees on HSA Usage: Offer educational resources, such as brochures, workshops, or online materials, to help employees understand how to use their HSAs effectively. Explain eligible expenses, reimbursement procedures, and the importance of keeping proper records.
Perform Ongoing Administration: Continuously monitor and manage the HSA program. Stay updated on any changes in HSA regulations and adjust your processes accordingly. Regularly communicate with employees to address their questions and provide support.

How Does an HSA Work?

As mentioned above, funds from an HSA are not subject to federal income tax. Employers, employees, or both can contribute to an HSA, up to the annual contribution limit set by the IRS each year.

Employees have a great deal of flexibility related to the use of these funds, as long as they are used to pay for qualified medical expenses. These expenses include a wide range of healthcare-related costs such as doctor's visits, prescription medications, dental care, vision expenses, and even certain over-the-counter items.

HSAs can also cover expenses for spouses and dependents, making it a comprehensive solution for managing healthcare costs for the entire family.

Employees can use a dedicated HSA debit card to access their HSA funds. They can also pay out-of-pocket for qualified expenses and later reimburse themselves from their HSA account. It's important to keep receipts and documentation to support the eligibility of expenses for tax purposes.

Additionally, HSAs often offer investment options to allow the growth of funds over time. Employees can choose to invest their HSA contributions in various investment vehicles such as mutual funds, stocks, or bonds. This option enables their HSA to potentially grow through investment returns, providing an opportunity for long-term accumulation.

Consider providing your employees with educational materials related to the use of their HSA to help them get the maximum benefit from this solution!

5 Things You Need to Know About HSAs

1. Cost Savings

One of the most significant advantages of offering an HSA is the potential for cost savings, both for you and your employees!

Since employees are responsible for a higher deductible under a high-deductible health plan (HDHP), monthly premiums for the business tend to be lower. This cost-sharing arrangement can help businesses save on healthcare expenses while providing employees access to necessary medical services.

On the other hand, employees can save money through the pre-tax savings of their HSA funds, making this solution a win-win.

2. Tax Savings

As briefly mentioned, tax savings are one of the key benefits of an HSA. When employees contribute to their HSAs through pre-tax payroll deductions, it reduces their taxable income.

Reduced taxable income for your employees results in payroll tax savings for employees and employers. The contributions made to HSAs are tax-deductible, and the interest or investment gains within the HSA grow tax-free.

These tax advantages can provide significant savings and incentives for employees to actively contribute to their HSAs.

3. Employee Control

HSAs empower employees by giving them more control over their healthcare expenses. With an HSA, employees can decide how they utilize their funds and where they allocate their healthcare dollars.

This control fosters a sense of ownership and responsibility for their health and well-being. By giving employees greater control, businesses can contribute to a better benefits experience and overall employee satisfaction.

4. Employee Wellness

What employer doesn’t want their employees to be healthier and more productive? An HSA can result in just that for your business!

Implementing HSAs can contribute to a culture of wellness and financial responsibility. Encouraging employees to actively manage their healthcare expenses and make informed decisions promotes a proactive approach to health and wellness.

This approach can result in better employee health outcomes, increased productivity, and improved efficiency across the team. HSAs align with the growing focus on holistic employee well-being, addressing both physical and financial health.

5. Attract and Retain Employees

Last but not least, offering an HSA as part of your benefits package can be a valuable tool for attracting and retaining talented employees.

HSAs have become increasingly popular among job seekers. Modern job seekers value the flexibility, tax advantages, and control that HSAs provide. Including an HSA as part of your benefits offering can set your business apart from competitors and be an appealing incentive for current and potential employees.

Offering an HSA to your employees demonstrates your commitment to employee financial wellness and positions your business as an employer of choice in the competitive job market.

Potential Drawbacks of an HSA

While HSAs offer your business many advantages, no solution is perfect! As a result, you need to be aware of potential drawbacks. One potential drawback is the possibility of incurring penalties and fees.

If HSA funds are used for non-qualified expenses before the account holder reaches the age of 65, they may be subject to penalties and taxes. Understanding the IRS guidelines for qualified expenses is essential to avoid any unintended financial consequences.

Additionally, some HSAs may come with additional fees. These fees can include monthly maintenance fees, per-check charges, or fees for using an ATM to withdraw funds. It's crucial for individuals to carefully review the terms and conditions of the HSA provider to understand the potential fees involved.

Pro-Tip: Comparing different HSA options and providers can help mitigate the impact of these potential drawbacks and find a solution that best suits individual needs.

Connecting With an HSA Expert

This post should give you the basis of information you need to know to get started offering HSAs to your workforce. However, for the best results, you may want to partner with an expert in the field who truly understands all the ins and outs of all things HSA!

Connecting with an HSA expert through a payroll service provider offers numerous benefits for businesses and their employees. These experts possess in-depth knowledge about healthcare savings options, enabling small businesses to make informed decisions. By tapping into their expertise, businesses can confidently navigate the complex landscape of HSAs.

One key area where an HSA expert can offer invaluable guidance is in understanding different aspects of HSAs, including contributions, tax advantages, and regulatory compliance. They can provide detailed insights into the rules and regulations governing HSA contributions, ensuring that businesses and employees stay compliant with the ever-changing healthcare landscape.

ConnectPay can connect you with an HSA expert to help with all of this and more. Or, to learn more about the basics of small business payroll, check out our free Connected Guide today!