An HSA Can Be Advantageous for Some, But Not All, Federal Employees

Considering a High Deductible Health Plan this FEHB Open Season? Learn how an HSA can help with costs

Edward A. Zurndorfer

A Health Savings Account (HSA) is a tax-advantaged savings account created for individuals who have health insurance associated with a high deductible health plan (HDHP). Regular contributions are made by the employee and employer to the HSA in a tax beneficial way. Tax-free withdrawals from the HSA can be made to pay for qualified medical expenses not covered by the HDHP.

Contributions made to an HSA have an annual limit each year as imposed by the IRS. Withdrawals can be made to pay for medical, dental and vision care as well as prescription drugs. In addition, the Coronavirus Aid, Relief and Economic Security (CARES) Act, enacted in 2020 in response to the COIVD-19 pandemic, allows HSA withdrawals to be used to pay for over-the-counter medications without a prescription as well as for some other health-related products.

The HSA offers three tax advantages to its owners in what has been call the “trifecta” tax effect. These advantages are: (1) Tax-deductible contributions; (2) tax-free earnings; and (3) tax-free distributions. These are discussed below.

• • Tax-deductible contributions. Contributions made to an HSA are 100 percent federal income tax-deductible, up to the annual HSA contribution limit as imposed by the IRS. Contributions made to the HSA owner are similar to a deductible traditional IRA made by the IRA owner. Both HSA and a deductible traditional IRA contribution are reported on one’s federal income tax return as an adjustment to income (an “above the line” deduction). In other words, an individual does not have to itemize (file Schedule A) on his or her federal income tax return in order to get any tax benefit when the individual contributes to his or her HSA. But unlike a deductible traditional IRA, there are no adjusted gross income (AGI) limits for contributing to one’s HSA. Most federal employees have AGI’s that exceeds the limit each year to allow them to contribute to a deductible traditional IRA.
• Tax-free earnings. HSAs accrue earnings (capital gains, dividends, interest depending on how the HSA is invested) which accumulate tax-free over time, if when the earnings are withdrawn, they are used to pay for qualified medical, dental and vision expenses.
• Tax-free distributions. Withdrawals from an HSA are tax-free if the withdrawals are used to pay for qualified medical, dental and vision expenses.

In order to contribute to an HSA during any year, a federal employee must be enrolled in a high deductible health plan (HDHP) as offered in the Federal Employees Health Benefits Program (FEHBP). Each year the IRS defines the minimum deductible in order for a health plan to be considered as an HDHP. For 2022 the minimum deductible is $1,400 for a self-only health plan and $2,800 for self plus one and self and family health plans. The HDHP must also have an annual out-of-pocket maximum each year which caps the HDHP policyholder’s out-of-pocket medical expenses. For 2022, the maximums are $7,050 for self-only coverage and $14,100 for self-plus one and self and family during 2022.

In addition to being enrolled in an HDHP, a federal employee who wants to contribute to his or her HSA cannot be enrolled in either: (1) Medicare – any part (Medicare Part A, Part B, Part C or Part D); and (2) Any additional health insurance plan associated with a non-HDHP health plan, either themselves or through a spouse. Also, an employee who wants to contribute to his or her HSA cannot be claimed as a dependent on someone else’s federal income tax return. Note that being enrolled in a federal or private dental, vision or long-term care insurance plan will not disqualify an employee from participation in an HSA.

Federal employees who enroll in the health care flexible spending account (HCFSA) cannot enroll in a HDHP associated with an HSA. But they could enroll in what is called a “limited expense” health care flexible spending account (LEXHCFSA) (that pays for out-of-pocket dental and vision expenses only) while being enrolled in an HSA. For more information about the LEXHCFSA, go to www.fsafeds.com.

The maximum contribution to an HSA during 2022 is $3,650 for employees and who have self-only FEHBP enrollment. The maximum contribution limit for self plus one or self and family FEHB enrollment is $7,300 during 2022. Employees 55 years or older by the end of 2022 can make “catch-up” contributions of an additional $1,000. As will be discussed below, the annual contribution limits on HSA contributions for FEHBP HDHPs include a certain amount of the federal government’s contribution to the employee’s/annuitant’s HDHP premiums – the “premium pass-through” – and the employee’s/annuitant’s voluntary contribution. The following example illustrates:

Example 1. Francine, age 45, is enrolled in an FEHBP HDHP associated with an HSA. She has self-only coverage. In 2022, Francine’s HDHP has a “premium pass-through” of $2,000. Francine can contribute on her own an additional $1,650 to her HSA during 2022. She has until April 17, 2023 – tax-filing deadline for 2022 – to make her voluntary HSA contribution for calendar year 2022.

As will be discussed and shown below, employee or annuitant voluntary contributions to an HSA are an adjustment to income on one’s federal income tax return. The result is a lowering of one’s adjusted gross income (AGI).

The following is a list of nationwide FEHBP health insurance plans offering HDHPs associated with HSAs during the 2022 plan year.

List of Nationwide FEHBP HDHPs During 2022

An HSA is administered by a trustee or custodian, similar to an IRA. If the HSA owner dies, then a spousal beneficiary can inherit the HSA and use it as his or her own, making qualified withdrawals to pay for out-of-pocket medical, dental, and vision expenses. Non-spousal HSA beneficiaries (for example, children), must withdraw funds from the HSA, paying federal and state income taxes on the amounts withdrawn, but no early withdrawal penalty.

Penalties for Using HSA Withdrawals to Pay Nonqualified Expenses

HSA owners under the age of 65 who are not totally and permanently disabled and who make HSA withdrawals to pay non-qualified medical expenses are subject to a 20 percent early withdrawal penalty, in addition to federal and state income taxes on the amounts withdrawn from the HSA.

How the HSA Typically Works

If an individual enrolls in an HDHP associated with an HSA for the year 2022, the individual must pay the qualifying medical expenses up to HDHP annual deductible before the HDHP starts paying. In 2022, the self-only deductible is a minimum $1,400 while the self plus one and self and family, the minimum deductible amount is $2,800. Once the individual has reached the deductible, the HDHP covers a percentage of the expenses. For instance, the HDHP covers 80 to 90 percent of the qualified expenses while the individual pays the remaining 10 to 20 percent, or a specific co-payment dollar amount. The individual can withdraw from the HDHP (tax-free) to pay his or her portion of the expense, or they can pay “out-of-pocket” in order to preserve HSA funds for future use. The following example illustrates.

Example 2. David is a federal employee and during 2021 he is enrolled in an HDHP associated with an HSA. His annual deductible is $1,500. In 2021, David incurred a medical claim of $3,500 of which he paid the $1,500 to cover the annual deductible. David had to pay under this HDHP policy rule 15 percent of the remaining $2,000, or $300, and the HDHP covered the rest. Note that David could have withdrawn from his HSA to help pay some or all of the $1,500 deductible and $300 co-payment towards paying the $3,500 qualified medical expenses.

Once the annual deductible is met in a given plan year, any additional medical expenses are typically covered by the HDHP with the exception of any uncovered costs under the contract, such as co-pays. There is an annual maximum out-of-pocket cost for the HSA owner each year. For 2022, $7,050 for self and $14,100 for self plus one and self and family.

Steps for an Employee to Participate in an HSA Starting in the 2022 Plan Year

• 1. During the current ‘open season” which concludes Dec. 13, 2021, the employee enrolls in an HDHP as listed in the FEHBP website.
• 2. The employee’s HDHP establishes an HSA with a custodian. Each HDHP has more information on how this step works in the HDHP Plan brochure.
• 3. The HDHP each pay date automatically contributes a portion of the employee’s HDHP bi-weekly premium into the employee’s HSA – the “premium pass-through”.
• 4. The employee can make additional contributions to their HSA, up to the IRS’ annual maximum contribution limit. For 2022 – $3,650 for self only; $7,300 for self plus one or self and family; plus, HSA owners over age 55 can make an additional $1,000 contribution.
• 5. The HDHP will provide the employee and members of the employee’s family who are included as part of the HDHP family enrollment coverage for preventive medical care, such as well visits, with “first dollar” coverage. They need not meet the annual deductible first.
• 6. The employee pays the full cost of non-preventive care for the employee and family members enrolled as part of self plus one or self and family enrollment, using either by: (1) using their own funds (savings) or (2) withdrawing funds from HSAs, up to the annual deductible.
• 7. Once an employee has reached his or her annual maximum out-of-pocket limit, the HDHP will then cover needed medical care to the employee and enrolled family members with the employee having no out-of-pocket expenses. This assumes that the employee and family members utilize in-network doctor and hospital providers.

Advantages and Disadvantages of an HSA

HSAs have several advantages and disadvantages. How an HSA can benefit a federal employee depends on the employee’s personal and financial situation. The following are some advantages and disadvantages for federal employees who own an HSA:

Advantages

• “Premium pass-through” decreases an employee’s gross salary resulting in federal and in most states, state and local income tax savings. Employee direct contributions to an HSA (up to the annual IRS HSA contribution limit) are 100 percent deductible as an adjustment to one’s income, resulting in a reduction of the employee’s AGI and current year tax savings. The employee does have to itemize on his or her federal income tax return nor are there any current year limitations in order to be eligible for this current year tax savings.
• Any earnings in the HSA grow tax-free provided when the earnings are withdrawn, they are used to pay for qualified medical, dental and vision expenses.
• Distributions from an HSA are tax-free provided the funds are used for qualified medical expenses as outlined by the IRS. Distributions used for medical expenses that are covered by the HDHP are included in determining if the HDHP’s deductible has been met.
• Money in the HSA can be invested in stocks and other securities potentially resulting in tax-free, compounded investment growth of the account.

Disadvantages

• Limits on eligibility. HSA owners must be enrolled in a high deductible health plan and be able to afford to pay more out-of-pocket costs until the deductible is reached.
• Employees who cannot make their own individual contributions to the HSA during the year must be financially able to set aside an amount of money each year that would cover a substantial portion of their HDHP’s deductible and copayments and coinsurance that are the employee’s responsibility. Those employees with little spare cash may find this burdensome. • HSAs come with IRS filing requirements regarding contributions and distributions, and a record-keeping burden that some employees may find to be burdensome.

    Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be dependable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those, Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

HSA can be advantageous