The Future of Your Health Savings Account in 2020 and 2021

According to the U.S. Treasury, "Health savings accounts (HSAs) were created in 2003 so that individuals covered by high-deductible health plans could receive tax-preferred treatment of money saved for medical expenses." Since then, HSAs have grown in popularity in the workplace.

In fact, a recent Employer Health Benefits Survey found that 31% of employees were enrolled in a high-deductible health plan and health savings account in 2020, up from 24% just five years earlier. The popularity of HSAs has been steadily increasing over the past 15 years, and certain factors are contributing to this trend toward the rise in HSAs.

What is an HSA?

To evaluate whether HSAs make good financial sense, employees must first understand what is an HSA, who is eligible to enroll, and acceptable uses for HSA funds. HSAs are designated financial accounts that come as an optional employee benefit to workers who also enroll in a qualifying high-deductible health plan (HDHP). Employees can choose to deposit funds into this account through payroll deduction to help cover qualifying medical expenses. For those in a high-deductible health plan, HSA funds can create a nest egg that can help minimize out-of-pocket medical expenses until the deductible is met.

Why are HSAs so popular?

Although HSAs have existed for less than 20 years, they have quickly grown in popularity due to their flexibility and tax advantages. Unlike traditional flexible spending accounts (FSAs), employees don't risk losing their contributions at the end of each plan year if they don't incur qualifying medical expenses.

HSAs offer a variety of unique and valuable benefits that have led to a significant increase in popularity.

Workplace flexibility

HSAs are an attractive benefit for both employers and employees. Employers can provide HSAs as an option for employees with little to no additional cost beyond a typical benefits package. Employees appreciate that there are minimal qualification requirements to take advantage of this benefit.

The only requirements to qualify for a health savings account are that the individual is covered by a high-deductible health plan (HDHP) and is not enrolled in Medicare. To qualify, employees must enroll in a plan that meets the IRS designations for an HDHP. The following requirements for 2020 and 2021 are:

Triple tax advantage

A major benefit to health savings account enrollment is the triple tax advantage available. According to the IRS, HSA contributors are eligible for the following tax benefits:

• Tax-deductible contributions: Employers may provide an option to make pre-tax contributions, such as through a cafeteria plan. If contributions are made post-tax, those contributions are deductible on the employee's annual income tax return.
• Tax-deferred account earnings: If the account is invested in a solid strategy with a menu of options and no maintenance fees, the account may earn additional value beyond employee or employer contributions. These investment returns will not incur tax. Tax-free distributions for medical expenses: The account owner can decide to take distributions to cover eligible medical expenses or leave the funds in the account for additional growth. When funds are released in the form of distributions for qualified medical expenses, they are tax-free.

Are HSA contributions subject to FICA and FUTA taxes?

Most contributions made to HSAs are tax-free. Employer contributions and employee salary reduction contributions are not subject to FICA or FUTA taxes. The only contributions subject to these taxes would be optional contributions made by employees separate from the payroll deduction process, though these contributions can be later deducted on the employee's personal tax return.

Retirement savings supplement

Although HSAs are designed to help cover out-of-pocket medical costs, these accounts can also be used to supplement retirement savings. Those who stay healthy or use non-HSA funds to pay medical costs can allow savings to build up in their accounts on a tax-deferred basis. Once the account owner reaches age 65, distributions can be taken for any reason without an additional tax penalty. At that point, distributions for qualifying medical expenses would be tax-free, while distributions for other reasons would be taxed similarly to IRA distributions.

Temporary legislative changes

As a result of the global health crisis related to COVID-19, the IRS recently introduced legislation designed to temporarily increase flexibility for employees with HDHPs and HSAs. IRS Notice 2020-29 provides allowances and exceptions for employees to use HSA funds for telehealth and other remote-care services.

This notice also expanded the definition of items that are designated as "qualified medical expenses", including some over-the-counter products and medications that previously weren't eligible for tax-free distributions.

What is the future of HSAs?

Although HSA participation has been steadily increasing for the past 15 years, many people wonder if this trend will continue. Several statistics indicate that the rise of HSAs hasn't peaked yet:

• The White House projects that 800,000 currently uninsured Americans will soon gain health coverage. As a result of new legislation that is set to expand affordable coverage, many workers will be newly eligible for health insurance plans, including HSAs.
• HSA growth is increasing significantly. According to Devenir Research, account balances in HSAs increased to almost $66 billion in funds across over 28 million accounts. More employees are using their HSAs and saving more into them.
• Most states have conformed to federal tax treatment of HSA contributions. Although the IRS allowed for tax deductions on HSA contributions, many states still assessed income taxes and capital gains taxes on HSA funds until recently. Now all states except for California and New Jersey mirror IRS guidelines for tax advantages on HSA contributions.

What does this mean for the future of HSAs? As more employees gain access to these accounts through employee benefits programs, more items are covered as qualifying medical expenses, and more account holders are learning how to use HSAs as a long-term investment, employees will have more incentives to contribute the maximum amounts allowed each year.

HSAs have a great deal to offer for both employees and employers, so companies not yet offering these accounts should explore their health plan offerings and consider incorporating this valuable benefit. As HSA offerings continue to expand, employers already offering HSAs should compare the terms of their current accounts with other available offerings to ensure they are taking advantage of plans with minimal fees and the best investment performance.