Health Savings Account


A Health Savings Account (HSA) is an account established under Section 223 for the purpose of paying qualified medical expenses incurred by the account beneficiary (eligible individual).

Both Individual HSAs and HSAs offered by employers are available. We focus on HSAs offered as an employee benefit for our purposes here.

HSAs allow employers and employees to make tax-free payroll contributions to the plan to pay for certain out-of-pocket medical expenses. By paying for these expenses on a pre-tax basis your employees increase their take-home pay without costing you more money. You, the employer, save on payroll taxes for all participating employees.

NOTE: An individual may establish an HSA only if they are first covered under a High Deductible Health Plan (HDHP). This means as an employer you must offer an HDHP in order to offer the HSA benefit.

Setting Up an HSA

Contributions to the HSA may be made pre-tax by the employee. Individual contributions are deducted pre-tax via payroll deduction throughout the Plan Year. The employee, the employer, or both may make contributions to the HSA account.

The non-discrimination rules applicable to a Cafeteria Plan are also applicable to HSA contributions (pre-tax). This includes both employer and employee contributions. The following Cafeteria Plan rules do not apply to HSAs:

  1. The prohibition against a benefit that defers compensation by permitting employees to carry over unused elective contributions or plan benefits from one plan year to another (the Use-It-Or-Lose-It rule).
  2. The mandatory 12-month period of coverage.
  3. Change-in-status rules.


It is best to add an HSA benefit during Cafeteria Plan renewal, as trying to add the benefit mid-year causes some problems. Technically, if the benefit is added mid-year, then the medical FSA must be changed to either a Limited Purpose FSA or a Post Deductible FSA.

In addition, after such a mid-year change, the employee would most likely want to change their annual contribution to their current medical FSA. Nonetheless, adding an HSA benefit mid-year is not considered a qualifying event, meaning a mid-year change to the medical FSA would not be allowed. Another option is to terminate the Section 125 Cafeteria Plan mid-year; however, how to handle the employee account balances is then another issue.

The HSA account may be established for an indefinite period of time. An eligible employee may contribute to the account only while they are covered under a qualified HDHP. Conversely, the employee may receive distributions from the account even when they are no longer covered under the HDHP.

The Plan Document should be amended by the Cafeteria Plan administrator to include the HSA as a benefit that is allowed under the plan. The document should be further changed to clarify that if a medical FSA is in effect, it will be considered a Limited Purpose FSA or a Post Deductible FSA henceforth, and as such may reimburse expenses that qualify only.

How Does It Work?

Pre-tax funds are deducted via payroll deduction and are deposited into a selected financial institution custodial account. When a qualified expense is incurred, the employee requests reimbursement from the HSA to pay for the expense.

This "request" can be handled in a variety of ways, based on the specifics of said account. Customarily, methods such as checks, debit cards, and so on are made available to HSA account holders.

Eligible HSA Expenses

Qualified medical expenses for HSA include costs for medical care as defined in Section 223(d) of the Internal Revenue Code, but only to the extent the expenses are not covered by insurance or otherwise. Generally health insurance premiums are not qualified medical expenses except for the following: qualified long-term care insurance, COBRA continuation healthcare coverage, and healthcare coverage while an individual is receiving unemployment compensation. The qualified medical expenses must be incurred after the HSA has been established.


If an individual is enrolled in Medicare, they are ineligible because Medicare is considered "other" coverage that would disqualify the individual from being able to establish the HSA.