Ryan Tiernan Q1 By: Ryan TiernanAIFA®, CFA

“I am a plan sponsor and have been tasked with deciding if we should offer an HSA alongside our 401k.  I am not terribly familiar with how an HSA works but, have heard it referred to as a “401k for health care”.  What should I know about HSAs?”

First things first: We commend you for your question and your willingness to help your employees better position themselves for a long and successful retirement.  You are correct in that health savings accounts (HSAs) have been referred to as 401(k)s for health care cost but, there are several key differences we should all be aware of when comparing the two.

The first and most imperative question you must ask is, are you currently or in the near future planning to offer a High Deductible Health Plan (HDHP) to your employees?  What can sometimes be overlooked is that an HSA can only be used in conjunction with a HDHP, sometimes referred to as an HSA eligible health insurance plan.  If your employees only have the more traditional HMO or PPO or are getting their health care through a spouse’s HMO or PPO, they would not be eligible to also participate in an HSA.  HRA and FSA can also add a level of confusion to the question and in short can be offered with an HSA but, only if the HRA and or FSA are limited in their coverage.

Once the initial hurdle of the coverage type is understood we can then move on to how an HSA is actually used in day to day health care consumption.  If an employee is participating in an HSA he or she can use the dollars that have been contributed to their account for qualified health care expenses, which are those listed in the IRS Code Section 213(d).  The amounts used for these types of qualified medical expenses are tax free upon withdrawal and have no additional penalties at the federal and state level.  If however, dollars are withdrawn and used for expenses that do not qualify as 213(d) expenses (buying a boat for example) then those dollars are taxed as ordinary income and also enjoy an additional 20% penalty levied by the IRS.  Currently there are only three states that do not also allow for state tax exemptions on HSA withdrawals (CA, AL & NJ).  Amounts can be contributed to an HSA in several ways but, the most efficient and relevant to a plan sponsor is via payroll deduction.  When contributions are made in this fashion the amounts can be income and FCIA tax free for both the employer and the employee which then positions those contribution amounts to also grow tax free and be withdrawn tax free for the previously discussed expenses.

Here is where the similarities of 401k and HSA begin to take shape.  To the untrained eye an HSA is a tax efficient savings vehicle to be used for current health care spending but, to the more savvy planners the idea of letting these HSA balances grow and compound year over year has become more popular.  When the HSA is better understood and differentiated from its siblings (HRA and FSA) it becomes clear that the HSA is a very efficient and very robust long term planning tool.  The balances in many HSAs can be both stored simply in a cash account for safe keeping or deployed into a host of investment options.  Once we integrate the investment picture to this benefit offering it becomes apparent that we now have an account that is offered in conjunction with an employer health plan, one that is funded most often with tax free dollars (both employer and employee contributions), one that offers multiple investment options and one whose dollars can be deployed for both current and future health care needs.  Putting those attributes into one benefit can be extremely powerful in setting our employees on the right track.  

I would be remiss to not mention that it is in fact these health care costs that are among the largest retirement concerns for both employers and employees alike.  A vehicle that can help them lower health care cost while simultaneously creating more efficient health care consumers and savers is one that cannot be ignored.

Although this is an overview of how the two accounts differ what we all need to be thinking about is how we best position our employees for success and give them as many tools in their saving and investing arsenal as possible.  Health Savings Accounts can be incredibly dynamic and efficient vehicles but, like so many others, education and adoption will be key components to our joint success.

Disclaimer: The information provided herein is general in nature and should not be construed as legal or tax advice, as such opinions can be rendered only when related to specific situations.

Ryan Tiernan

Ryan Tiernan is a Senior HSA Consultant at Access Point HSA. Mr. Tiernan founded Access Point, an HSA consulting and distribution company in 2015 while being a member of the retirement and investment community for over 15 years.

Ryan holds a B.S. with honors from the School of Public Health at the...

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