An HSA is a trust created exclusively for the purpose of paying qualified medical expenses of an account beneficiary.¹

An HSA must be created by a written governing instrument that states:

(1)     no contribution will be accepted except in the case of a rollover contribution (Q 413) unless it is in cash or to the extent that the contribution, when added to previous contributions for the calendar year, exceeds the contribution limit for the calendar year;

(2)     the trustee is a bank, an insurance company, or a person who satisfies IRS requirements;

(3)     no part of trust assets will be invested in life insurance contracts;

(4)     trust assets will not be commingled with other property, with certain limited exceptions; and

(5)     the interest of an individual in the balance of his or her account is non-forfeitable.²

HSAs are available to any employer or individual for an account beneficiary who has high deductible health insurance coverage (Q 394). An eligible individual or an employer may establish an HSA with a qualified HSA custodian or trustee. No permission or authorization is needed from the IRS to set up an HSA. As mentioned above, any insurance company or bank can act as a trustee. Additionally, any person already approved by the IRS to act as an individual retirement arrangement (IRA) trustee or custodian automatically is approved to act in the same capacity for HSAs.³

Although an HSA is similar to an IRA in some respects, a taxpayer cannot use an IRA as an HSA, nor can a taxpayer combine an IRA with an HSA.⁴ In certain situations, a taxpayer can take a qualified funding distribution from an IRA to fund an HSA (Q 414).

Contributions to an HSA generally may be made either by an individual, by an individual’s employer, or by both. If contributions are made by an individual taxpayer, they are deductible from income.⁵ If contributions are made pre-tax by an employer, they are excluded from employee income.⁶

An HSA itself is exempt from income tax as long as it remains an HSA.⁷

Contributions may be made through a cafeteria plan under IRC Section 125 (Q 3501).⁸

Distributions from HSAs are not includable in gross income if they are used exclusively to pay qualified medical expenses. Distributions used for other purposes are includable in gross income and may be subject to a penalty, with some exceptions (Q 413).⁹

An employer’s contributions to an HSA are not considered part of a group health plan subject to COBRA continuation coverage requirements (Q 356).¹⁰ Therefore, a plan is not required to make COBRA continuation coverage available with respect to an HSA.¹¹

The IRS has stated that a levy to satisfy a tax liability under IRC Section 6331 extends to a taxpayer’s interest in an HSA. A taxpayer is liable for the additional 20 percent tax (10 percent before January 1, 2011, under the ACA¹²) on the amount of the levy unless, at the time of the levy, the taxpayer had attained the age of 65 or was disabled.¹³

1.    IRC § 223(d)(1).

2.    IRC § 223(d)(1).

3.    Notice 2004-50, 2004-2 CB 196, A-72; Notice 2004-2, 2004-1 CB 269, A-9, A-10.

4.    See Notice 2004-2, supra.

5.    IRC § 223(a).

6.    See IRC § 106(d)(1).

7.    IRC § 223(e)(1).

8.    IRC § 125(d)(2)(D).

9.    IRC § 223(f).

10.      See IRC §§ 106(b)(5), 106(d)(2).

11.      See Treas. Reg. § 54.4980B-2, A-1 regarding Archer MSAs.

12.      Affordable Care Act.

13.      CCA 200927019.

HSAs are tax-driven accounts and, as such, many of the benefits are tax related. Some of the tax benefits of an HSA include the following:

(1)     Federal Income Tax Deduction. HSA contributions reduce an account owner’s income for federal income tax purposes because personal HSA contributions are tax deductible and employer contributions are received on a pre-tax basis (see Q 397).

(2)     State Income Tax Deduction. Most states with income taxes allow account owners to reduce state taxable income by the amount of an HSA contribution. California, New Jersey and Alabama are the only states that do not allow a state income tax deduction for an HSA contribution. All other states have either passed specific legislation allowing HSA deductions for state income tax purposes, have conforming legislation where the federal deductions flow through at the state level, or do not have a state income tax.

(3)     Payroll Tax Avoidance. Account owners receiving HSA contributions pre-tax through an employer, whether they are employer contributions or employee payroll deferral through a Section 125 plan, avoid Social Security taxes, Medicare taxes (together with Social Security referred to as FICA), federal unemployment taxes (FUTA), Railroad Retirement Act taxes, and in most cases state unemployment taxes (SUTA) (see Q 418).

(4)     Tax Deferred Earnings Growth. Any interest, dividends or other appreciation of the assets in an HSA grow tax-deferred while in the HSA (see Q 410).

(5)     Tax-free Distributions. Account owners that use HSA funds for qualified medical expenses enjoy tax-free distributions (see Q 411). If the funds will be used to pay for qualified medical expenses, the HSA rules are more advantageous than the tax treatment provided to distributions from traditional IRAs or 401(k)s because those plans are only tax-deferred, not tax-free (although Roth IRA and Roth 401(k) distributions are tax-free, as contributions are made with after-tax dollars).

The nontax benefits of HSAs are also significant, and include the following:

(1)     Balance Rolls Over. HSA balances roll over from year to year and do not have “use it or lose it” restrictions that apply to other medical spending account plans.

(2)     HSA Remains after Separation from Service. An HSA remains with the account owner after separation from service even if the employer provided the HSA funding.

(3)     Transferability. Account owners can move their HSA to a new HSA custodian at any time (see Q 413).

(4)     Ownership. HSA account owners own the money in their HSA and can use it as they see fit. This relates to other benefits already mentioned, but also provides account owners the ability to name beneficiaries on the account, select investments, and decide when to take a distribution (even if the distribution is for a nonmedical reason). Note that the penalty tax for non-qualified distributions does not apply once the taxpayer has reached age 65.

(5)     Control Spending. An HSA gives account owners some additional control over their medical spending. The account owner can decide where to spend the money and can negotiate with providers when appropriate. This gives the account owner some freedom to choose medical providers outside of an insurance company’s network or to try alternative approaches (within the definition of “qualified medical expense”).

(6)     Lower Insurance Premiums. HDHPs (which must be used in order for the individual to qualify for an HSA) are generally less expensive than traditional insurance.

For an individual unable to afford traditional insurance, the HDHP and HSA combination may provide an affordable approach to insurance not possible otherwise. Many people that can afford traditional insurance also choose HDHPs and HSAs because the combination reflects a cost savings and provides more pure insurance rather than pre-paid medical. This background is important because many of the disadvantages of HSAs are only in comparison to traditional low or no deductible health insurance. The following are potential disadvantages of a combination HDHP and HSA.

(1)     Higher Deductible. An account owner generally faces a higher health insurance deductible than a person with traditional insurance. This can present an increased cost burden.

(2)     Expenses before Savings. An account owner may face a large medical expense prior to having time to build a sufficient balance in the HSA.

(3)     More Responsibility for Health Spending. HSAs require individuals to take charge of their own health care spending. This will generally require the individual to devote more time to learning about health care costs and alternatives in order to save on health costs, as compared to a person with traditional insurance coverage where many expenses are simply paid.

(4)     Tax Reporting. Account owners are required to account for both HSA contributions and distributions each year on their income tax return. Additionally, the account owner is responsible for saving medical receipts in order to substantiate health-related expenses.

(5)     HSA Rules. HSAs, similar to all tax-driven types of accounts, can become complicated. The account owner is responsible for learning the HSA rules and following them in order to avoid negative tax consequences.

(6)     HSA Maintenance. The account owner is responsible for maintaining the HSA, paying medical bills, monitoring the balance, choosing beneficiaries, and otherwise maintaining the HSA.

For purposes of an HSA, an eligible individual is an individual who, for any month, is covered under a high deductible health plan (HDHP) as of the first day of that month and is not also covered under a non-high deductible health plan providing coverage for any benefit covered under the high deductible health plan.¹

An individual enrolled in Medicare Part A or Part B may not contribute to an HSA.² Mere eligibility for Medicare does not preclude HSA contributions.³

An individual may not contribute to an HSA for a given month if he or she has received medical benefits through the Department of Veterans Affairs within the previous three months. Mere eligibility for VA medical benefits will not disqualify an otherwise eligible individual from making HSA contributions.⁴ Beginning January 1, 2016, an individual shall not fail to be an eligible individual because of receiving hospital care or medical services under a law administered by the Secretary of Veterans Affairs for a service-connected disability. The IRS defines “service-connected disability” as the following:

“Distinguishing between services provided by the VA for service-connected disabilities and other types of medical care is administratively complex and burdensome for employers and HSA trustees or custodians. Moreover, as a practical matter, most care provided for veterans who have a disability rating will be such qualifying care. Consequently, as a rule of administrative simplification, for purposes of this rule, any hospital care or medical services received from the VA by a veteran who has a disability rating from the VA may be considered to be hospital care or medical services under a law administered by the Secretary of Veterans Affairs for service-connected disability.”⁵

A separate prescription drug plan that provides any benefits before a required high deductible is satisfied normally will prevent a beneficiary from qualifying as an eligible individual.⁶ The IRS has ruled that if an individual’s separate prescription drug plan does not provide benefits until an HDHP’s minimum annual deductible amount has been met, then the individual will be an eligible individual under Section 223(c)(1)(A). For calendar years 2004 and 2005 only, the IRS provided transition relief such that an individual would not fail to be an eligible individual solely by virtue of coverage by a separate prescription drug plan.⁷

An individual will not fail to be an eligible individual solely because the individual is covered under an Employee Assistance Program, disease management program, or wellness program, if the program does not provide significant benefits in the nature of medical care or treatment.⁸

Planning Point: An employer can provide an onsite medical clinic without jeopardizing employee HSA eligibility, provided the employer’s clinic does not provide “significant benefits in the nature of medical care” (in addition to disregarded coverage or preventive care). Meeting the exception depends on the level of services provided by the health clinic. Allowed services include the following:

• Physicals,
• Immunizations,
• Injecting antigens provided by employee,
• Providing aspirin/pain relievers, and
• Treatment of injuries or accidents that occur at work.

Certain kinds of insurance are not taken into account in determining whether an individual is eligible for an HSA. Specifically, insurance for a specific disease or illness, hospitalization insurance paying a fixed daily amount, and insurance providing coverage that relates to certain liabilities are disregarded.⁹

In addition, coverage provided by insurance or otherwise for accidents, disability, dental care, vision care, long-term care, telehealth visits, or other remote care will not adversely impact HSA eligibility.¹⁰

If an employer contributes to an eligible employee’s HSA, in order to receive an employer comparable contribution the employee must:

(1)     establish the HSA on or before the last day in February of the year following the year for which the contribution is being made and;

(2)     notify the appropriate contact person of the HSA account information on or before the last day in February of the year described in (1) above and specify and provide HSA account information (e.g., account number, name and address of trustee or custodian, etc.) as well as the method by which the account information will be provided (e.g., in writing, by e-mail, on a certain form, etc.).

An eligible employee that establishes an HSA and provides the information required as described in (1) and (2) above will receive an HSA contribution, plus reasonable interest, for the year for which contribution is being made by April 15 of the following year.¹¹

1.    IRC § 223(c)(1)(A).

2.    IRC § 223(b)(7).

3.    Notice 2004-50, 2004-2 CB 196, A-3.

4.    Notice 2004-50, 2004-2 CB 196, A-5.

5.    IRS Notice 2015-87.

6.    Rev. Rul. 2004-38, 2004-1 CB 717.

7.    Rev. Proc. 2004-22, 2004-1 CB 727.

8.    Notice 2004-50, 2004-2 CB 196, A-10.

9.    IRC § 223(c)(3).

10.   IRC § 223(c)(1)(B), as amended by CARES Act.

11.    TD 9393, 2008-20 IRB.

Editor’s Note: In response to the evolving COVID-19 pandemic, the CARES Act allowed HDHPs to cover the cost of telehealth services without cost to participants before the HDHP deductible has been satisfied. HDHPs providing telehealth coverage do not jeopardize their status as HDHPs. Plan members similarly retain the right to fund HSAs after taking advantage of cost-free telehealth services. The Consolidated Appropriations Act of 2022 (CAA 2022) extended the CARES Act so that HDHPs could provide first-dollar telehealth services from April 2022 through December 2022 (regardless of the plan year) without jeopardizing HDHP status. The remote services do not have to be related to COVID-19 or preventative in nature to qualify. Plans and participants should note that if the HDHP is a calendar year plan, the usual rules regarding the plan deductible apply between January 2022 and March 2022.¹ The 2023 year-end omnibus spending bill extended this relief again, although it should be noted that instead of beginning on January 1, 2023, the relief is effective for plan years beginning after December 31, 2022 and before January 1, 2025 (that means a gap will exist for non-calendar year plans from January 1, 2023 until the date that the plan year begins). The ability to provide pre-deductible remote health services is optional for employers.

Editor’s Note: Under the Inflation Reduction Act, HDHPs will be permitted to cover insulin prior to the participant satisfying the plan deductible effective for tax years beginning after December 31, 2022. This insulin coverage will not adversely affect a participant’s eligibility to contribute to an HSA. Going forward, HDHPs will be permitted to cover selected insulin products before the deductible is satisfied regardless of whether the participant has been diagnosed with diabetes. “Selected insulin products” is defined to include any dosage form, including vials, pumps, or inhalers of any type of insulin.

For purposes of an HSA, the requirements for a high deductible health plan (HDHP) differ depending on the coverage.

For 2024, an HDHP is a plan with an annual deductible of not less than $1,600 for self-only coverage ($1,500 in 2023). The family coverage deductible limit is $3,200 ($3,000 in 2023). Annual out-of-pocket expenses for an HDHP cannot exceed $8,050 in 2024 ($7,500 in 2023) for self-only coverage. For family coverage, the annual out-of-pocket expense limitation is increased to $16,100 ($15,000 in 2023).² These annual deductible amounts and out-of-pocket expense amounts are adjusted for cost of living. Increases are made in multiples of $50.³

For this purpose, family coverage is any coverage other than self-only coverage.⁴

The chart below includes the current year’s HDHP limits as well as the limits in place for previous years.

HSAs are generally not subject to the Employee Retirement Income Security Act of 1974 (ERISA).¹ HSA plans avoid much of the complexity that goes with an ERISA covered plan, making it a good choice for employers desiring greater simplicity. An employer that exercises too much discretion over employees’ HSAs could cause an employer HSA program to become an ERISA plan, but that is not likely.

Planning Point: In April, 2016, the Department of Labor introduced new rules defining who is a “fiduciary” in relation to providing investment advice (Q 396). These rules were vacated by the Fifth Circuit in 2018 and the DOL has proposed a new PTE 2020-02.

To avoid ERISA coverage, the establishment of an HSA must be completely voluntary on the part of the employee and the employer cannot do any of the following:

• Limit the ability of eligible individuals to move their funds to another HSA beyond restrictions imposed by HSA law.
• Impose conditions on utilization of HSA funds beyond those imposed by HSA law.
• Make or influence the investment decisions with respect to funds contributed to an HSA.
• Represent that the HSAs are an employee welfare benefits plan.
• Receive any payment or compensation in connection with an HSA.

A common practice of employers offering HSAs is to select one HSA provider for all employees to simplify employer administration of the plan. This practice, in itself, does not violate any of the above conditions.² However, a concern exists if that HSA provider limits investment options. The Department of Labor (DOL) states “the mere fact that employer selects an HSA provider to which it will forward contributions that offers a limited selection of investment options … would not, in the view of the Department, constitute the making or influencing of an employee’s investment decisions giving rise to an ERISA-covered plan so long as employees are afforded a reasonable choice of investment options and employees are not limited in moving their funds to another HSA.” The DOL, however, also states: “[t]he selection of a single HSA provider that offers a single investment option would not, in the view of the Department, afford employees a reasonable choice of investment options.”³

A couple of other common employer practices are also permitted without an HSA program becoming subject to ERISA. An employer can pay for fees associated with the HSA without the plan becoming an ERISA plan.⁴ An employer can unilaterally open an HSA for an employee and deposit employer funds into that HSA and still meet the “completely voluntary” requirement to avoid ERISA coverage.⁵

The employer cannot receive a discount on another product offered by the HSA custodian in exchange for using the custodian for its employees’ HSAs.⁶

If an HSA program is covered by ERISA, the employer must: (1) file the Form 5500 annually, (2) provide employees with Summary Plan Descriptions (SPDs), (3) be a fiduciary for the plan, and (4) meet other ERISA imposed terms. HSAs are not designed as ERISA plans and employers generally should seek to avoid ERISA coverage. If the plan does become an ERISA plan, the employer will face a number of challenging questions in applying ERISA to an HSA program.

1.    DOL FAB 2004-1

2.    DOL FAB 2004-1; DOL FAB 2006-02, A2.

3.    DOL FAB 2006-02.

4.    DOL FAB 2006-02, A5

5.    DOL FAB 2006-02, A1

6.    DOL FAB 2006-02, A7.

Editor’s Note: The Fifth Circuit vacated the DOL fiduciary rule in 2018. The DOL has introduced a new exemption to the prohibited transaction rules to replace the 2016 rule. The exemption follows the basic concepts of the original rule. It remains uncertain how this new standard will impact HSA programs. See Q 3983 for more details.

While the discussion below regarding the rules themselves are no longer entirely applicable, those who deal with HSAs may take note of the concepts that the DOL has found important, as they are the guiding concepts involved in the new proposed exemption.

The DOL’s 2016 rule expanded the definition of a fiduciary so that it would apply in the context of providing investment advice for an HSA.¹ The rule made HSA custodians (and potentially others) fiduciaries if they provided investment advice or recommendations for a fee or other compensation with respect to HSA assets. Although the previous rule also potentially made HSA custodians and others fiduciaries if they provided investment advice, the 2016 DOL rule applied in a wider array of advice relationships.

The rule was designed to remove loopholes in the industry that allowed for providers to earn commissions or fees for investments that may not have been in the best interest of the HSA owner (the rule primarily addresses concerns over conflicts of interest in the IRA industry). Under the prior rule, the provider may not have been a fiduciary and thus would not have had an obligation to recommend the investment best suited for the HSA owner. Under the 2016 definition, any individual receiving compensation for providing advice that was individualized or specifically directed to an HSA owner (or sponsor) was a fiduciary. The rule provided a number of exceptions (“carve-outs”) and explanations that assist in determining whether or not an HSA custodian (or other person/entity) fell within this definition.² The 2020 exemption conforms to the pre-2016 “five part test” for determining fiduciary status.

The DOL specifically included HSAs as subject to the final rule in the preamble to the rule. The DOL views HSAs as vehicles similar to IRAs and accordingly included HSAs in the rule. The DOL supports the inclusion of HSAs by noting that: (1) HSAs are given tax preferences (the DOL makes a distinction between tax-favored investment accounts and other investment accounts), (2) HSAs may have associated investment accounts that can be used as long-term investment accounts (HSAs are not just short term medical spending accounts), (3) HSAs may be invested in assets approved for IRAs (stocks, bonds, mutual funds and more), (4) HSA custodians may restrict investments (could open a conflict of interest situation), (5) HSA assets are large and growing, and (6) HSAs are already subject to the prohibited transaction rules (similar to IRAs). The DOL concludes by stating: “[t]hus, although they generally hold fewer assets and may exist for shorter durations than IRAs, the owners of these accounts and the person for whom these accounts were established are entitled to receive the same protections from conflicted investment advice as IRA owners.” The actual final rule included “health savings account” within the definition of IRA thus subjecting HSAs to the 2016 rule in the same manner as IRAs.³

Given that many HSAs are only invested in deposit or checking type accounts, one area of concern for HSAs is whether or not a person could become a fiduciary when the only investment offered is a deposit account. The DOL addressed this issue by providing that Certificates of Deposits are considered an investment subject to the rules (presumably this logic would include checking, savings and other similar deposit accounts as well).⁴

Another concern for HSAs is that the DOL includes in the definition of “providing investment advice” recommendations regarding “rollovers or distributions.”⁵ Recommendations regarding the distribution options on HSAs may not seem to be investment advice; however, the rule specifically includes it. The DOL also includes recommendations to make a rollover (presumably from an IRA or even another HSA).

Planning Point: The DOL rule provided exceptions for general communications and investment education which include providing plan information. For many involved with HSA programs, these communication exceptions would have offered an avenue to provide clients with important tax and plan information without providing investment recommendations.

Some HSA providers have satisfied an exception in the 2016 rule for recordkeepers and third-party administrators that provide a platform of investment alternatives to participant-directed retirement accounts and do not provide investment advice. To qualify, the communication cannot consider the individual needs of the participant. The provider must disclose in writing to an independent plan fiduciary that it is not intending to provide impartial investment advice or give advice in a fiduciary capacity. The provider must also identify investment alternatives that meet objective criteria. In order for this exclusion to apply, the plan fiduciary must be independent of the person who markets or makes the selection available. Note: this requires the existence of an independent plan fiduciary which may not be the case in HSA programs.⁶

The DOL removed the “best interest contract” exemption when the 2020 exemption was released. The best interest contract exemption would have allowed financial institutions or advisors that would otherwise be subject to the fiduciary rules to continue compensation arrangements that might violate the prohibited transaction rules absent an exemption.

1.    DOL RIN 1210-AB32 (released April 8, 2016)(81 FR 20945).

2.    29 CFR § 2510.3-21.

3.    DOL RIN 1210-AB32 (released April 8, 2016)(81 FR 20945), CFR § 2510.3-21(g)(6)(ii).

4.    81 FR 21089.

5.    CFR § 2510.3-21(a), DOL RIN 1210-AB32 (released April 8, 2016)(81 FR 20948).

6.    29 CFR §2510.3-21(a)(definition of investment advice), 29 CFR § 2510.3-21(g)(3) (definition of fee), 29 CFR § 2510.3-21(b)(2)(i) (platform providers).