Mercer Experts Hash Out Post 2018 HSA Contribution Strategy 

A question relating to last week’s posts about managing health savings accounts (HSAs) after the excise tax goes into effect prompted an interesting discussion among the authors (and their go-to compliance expert) about the pros and cons of continuing to offer employees the opportunity to make pre-tax payroll HSA contributions. We thought we’d share it in Q&A form so you can follow along. Warning — it gets a little complicated, but that’s the nature of the beast. Welcome to our world.

Dee (an astute reader): The vast majority of employers that offer HSA-qualified high-deductible health plans (HDHPs) offer the ability for employees to make pre-tax payroll HSA contributions and even encourage them to do so. For now, such contributions count towards the calculation of the gross cost of “high cost” health coverage for excise tax purposes. Should employers take away the pre-tax payroll HSA contribution feature from their cafeteria plans? Otherwise, an HDHP with a lower gross cost than a traditional PPO plan may actually end up triggering a greater excise tax because any employee pre-tax payroll HSA contributions would get tacked on to the total cost of the employer’s health coverage.

Joe K. (author of Managing FSAs to Avoid the Excise Tax): First, how confident are we that employee pre-tax payroll HSA funding will count toward the excise tax? Can employers hold out hope they won’t need to make a change?

Dorian (compliance expert): We won’t know for sure until we receive formal regulations next year. However, our current understanding based on the existing legislation, as well the proposed position that the IRS telegraphed in their “pre-guidance” issued earlier this year, is that employee pre-tax payroll HSA funding will count toward the excise tax.

Jay (author of Health Savings Accounts and the ACA): I would advise a plan sponsor to consider a hybrid approach — continue permitting (or making) pre-tax payroll HSA contributions up to the excise threshold, at which point any remaining allowable HSA contributions are made post-tax. For the employee’s convenience, the employer would facilitate employees’ post-tax HSA contributions via payroll.

Joe B. (author of The Unlimited Possibilities of the Limited-Purpose FSA): Well, ideally we want to optimize. But it seems to me to be more complex to have both pre- and post-tax HSA payroll contributions, rather than just going all post-tax with the employee claiming an above-the-line deduction for the entire HSA contribution when filing federal and state tax returns. I realize there is a little efficiency and tax savings lost, but that needs to be weighed against administration and communication considerations. Further, the employer could make a contribution when cost is within the thresholds, and let the employee contributions go post-tax.

Jay: Either a hybrid model or the seemingly simple move from pre- to post-tax brings administrative and communication considerations. Meanwhile, the efficiency opportunity could be substantial for the employer and warrant a hybrid model. I’d not likely recommend that an employer drop employee pre-tax payroll HSA contributions entirely unless the payroll/admin modifications were going to absorb at least half the current-year tax savings.

Joe B.: Good point. And now that I think about it, it’s really not any different than what some 401(k) plans do. If I elect to contribute more than the tax-favored limit, I can click a box to have the excess amounts contributed on an after-tax basis.

Joe K.: Although in some situations the tax savings just won’t be that high. We can estimate based on employer-specific data, such as the current level of employee funding and employee pay relative to the FICA limit.

Dorian: Keep in mind that if you don’t allow pre-tax payroll contributions through a cafeteria plan, you must meet the rigid, and often unworkable, HSA comparability rules for employer HSA contributions — which are especially problematic where an employer provides matching HSA contributions or HSA contributions based on wellness activities. Avoiding the comparability rules is one of the substantial benefits of allowing employee pre-tax payroll HSA contributions.

Joe K.: Some employers provide the same HSA funding to all employees. However, it sounds like eliminating an employee’s ability to make pre-tax payroll HSA contributions can be very limiting.

Dorian: It can be. To meet the comparability requirement, an employer generally needs to offer specified classes of “comparable participating employees” the same level of HSA funding. That not only effectively prevents an employer from using an HSA for wellness incentives, it may also mean the employer can’t vary HSA funding by salary band (certain exceptions apply). And there are other requirements as well, so if you do plan to meet the comparability rules, you’ll want to take a close look at all of the associated provisions.

Jay: Can an employer avoid these comparability rules if employees can partially fund their HSA on a pre-tax basis? If so, it sounds like another reason to consider a hybrid model.

Dorian: Possibly, but the law is not clear. We need to continue monitoring developments in this area.