I Love Health Savings Accounts

You know I love the Health Savings Account (HSA). If you didn’t know that, click here to see why. HSAs are only available for individuals and families who have a health insurance plan called a High Deductible Health Plan (HDHP). To be more specific, anyone can have an HSA and use any existing HSA balance to pay medical bills, but you must have a HDHP in order to contribute to an HSA. There are two ways to make contributions to your HSA. You can make HSA contributions through payroll (similar to your 401(k) contributions) or you can directly transfer money or write a check to your HSA out of your personal account. What is the best way to make contributions? Why don’t we compare them?

Choosing Your HSA Provider

HSAs can be confusing because they are typically tied to your employer that carries your health insurance like a 401(k) is specifically tied to your employer that carries your retirement plan. However, HSAs actually operate more like an Individual Retirement Account (IRA), independent of your employer. Some employers only allow their employees to use one HSA provider. Other employers allow the employee to choose from numerous HSA providers and to just provide the HR department with the routing and account number of the selected HSA, so they know where to send your contributions. If your employer allows you to choose your HSA provider, this website has a great comparison tool to help you make a selection.

Contributions Through Payroll

The typical (and best) way to make HSA contributions is directly from your employer through payroll. Every dollar you contribute to your HSA through payroll not only lowers your income tax but also lowers your payroll tax. Payroll taxes are the social security and Medicare taxes (FICA) that is taken out of every paycheck you receive. The HSA is one of very few accounts where contributions reduce payroll taxes. This is one of the reasons why the HSA is so powerful. For those with a 2020 salary of $137,700 or less, your payroll tax rate is 7.65%. This flat rate multiplied by the 2020 family coverage contribution limit for those under age 55 ($7,100) generates 2020 payroll tax savings alone of $543.

Contributions Through Transfer or Check

The other avenue to fund your HSA is directly out of your personal bank account. The important difference is that these contributions do not reduce payroll taxes. If you make a direct contribution to your HSA you will deduct the contribution amount on your tax return which will generate income tax savings but there will be no associated payroll tax savings. In other words, for the scenario above, it is $543 more expensive to fund an HSA directly as opposed to through your paycheck. The below chart shows the estimated 2020 tax savings assuming a 22% income tax rate on the maximum family coverage contribution of $7,100 for salaries below $137,700.

So, why would anyone make direct contributions? The deadline to make HSA contributions is April 15th of the year following the year for which you are making the contribution. The last day to make a 2020 contribution to your HSA is April 15, 2021. However, the only way to make a 2020 contribution after December 31, 2020 is through a direct transfer or check. Your HR department will not make a 2020 HSA contribution out of your 2021 paychecks.

Take A Look Before Year End

If you are reading this and considering your HSA contribution amount before the end of the calendar year, consider maximizing your contribution through payroll to the extent you can. Many employers will allow you to change your HSA deferral amount during the year meaning it is not too late to max out the HSA even if there are only a few months left. Alternatively, if you are reading this after the calendar year but before April 15th, do not let the lack of payroll tax saving deter you from fully funding the HSA directly. Instead, fully fund the HSA to the extent you can out of your personal funds and then contact your employer to change your deferral for future years to make sure you maximize your payroll tax savings.