Health Savings Accounts and the ACA

One of the more prevalent employer strategies to avoid the excise tax is to offer an account-based, consumer-directed health plan (CDHP), structured to coordinate with a health reimbursement arrangement (HRA) or health savings account (HSA). These plans generally cost less than traditional medical plans of comparable value, and nearly two-thirds of all large employers and about one-third of small employers already offer or say they expect to offer a CDHP within three years.

Despite their growing importance, a key consideration related to HSA-compatible plans hasn’t yet received much attention. These plans can allow participants to enjoy a greater level of tax-protected benefit than a traditional plan of equal cost because the protection can extend beyond the excise tax cost threshold. Here’s how.

HSA-compatible CDHPs permit both the employer and employee to contribute to the employee’s account, up to the statutory limits. These limits are indexed annually. For 2016 they are:

  • $3,350 for single coverage.
  • $6,750 for family coverage.

Funds deposited in an HSA enjoy unique “triple tax-protected” treatment under the Internal Revenue Code. Specifically, contributions are tax-deductible, earnings are tax-free, and distributions used to pay for qualifying health care expenses are tax-free as well. Contributions can be made on a pre-tax basis thru payroll via an employer’s cafeteria plan, or by depositing post-tax funds. In the former case, both employer and employee contributions count toward the excise threshold; in the latter case they don’t, and the HSA owner is permitted to take a tax deduction when filing his or her federal (and in most cases, state) income tax return.

So, what does this have to do with the excise tax? Well, assume an employer offers two plans:

  1. A traditional PPO with a cost of $10,200 for single coverage.
  2. An HSA-based CDHP to which the employer contributes $500 for single coverage, and whose cost excluding the employer contribution is $9,700 such that the total cost is also $10,200.

In this case, the traditional PPO allows the employer to deliver — and the participant to receive — $10,200 of tax-free health benefit. Alternatively, the HSA-based option allows the employer to deliver the same benefit, but permits the participant to tax-shelter substantially more thru post-tax, tax-deductible HSA contributions.

Specifically, assuming the 2018 HSA contribution limits are no greater than those for 2016, the availability of post-tax HSA contributions, which are deductible on individual tax returns, effectively increases the thresholds at which the excise tax becomes a consideration to:

  • $13,550 for those with single coverage ($10,200 plus the $3,350 statutory HSA contribution limit).
  • $34,250 for those with family coverage ($27,500 plus the $6,750 statutory HSA contribution limit).

These figures are likely conservative, since the HSA contribution limits will almost certainly be higher in 2018 than 2016. Further, they don’t contemplate the additional $1,000 catch-up contribution available to HSA-eligible participants ages 55+. Regardless, the ability to contribute and deduct post-tax funds to an HSA increases the 2018 thresholds at which the excise tax becomes a consideration by at least 32% and 24% for single and family coverage, respectively. This dynamic is only achievable using an HSA-compatible plan; no other medical plan offers this feature.

The growth of HSA-compatible plans has been driven by their ability to contain cost and engage participants, and the fast-approaching excise tax on high-cost plans has only accelerated that trend. The availability of tax-deductible post-tax contributions that don’t accrue toward the excise tax thresholds offers yet another reason for employers to consider implementing these plans. If you already have an HSA strategy in place, you might want to rethink how you position your plans as the cost approaches the excise tax threshold levels. If employees understand the tax advantages, they may be more inclined to select the HSA-compatible plan in 2018, or beyond.

Jay Savan
by Jay Savan

Partner, Mercer

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