Did you know that you can receive different types of tax deductions depending on how you obtain your health savings account (HSA), and how the account is structured? Yep.
If your employer offers an HSA under a Section 125 salary reduction
agreement—basically, the regulation that allows them to offer you tax-free contributions in the first place—then said employer is contributing from your earned income before
calculating your withholding and payroll taxes for that pay period.
Since these pre-tax contributions are not considered income, getting contributions payroll-deducted also means that you’ll pay less withholding taxes on a smaller amount of income, which impacts your
payroll taxes deducted to fund Social Security, Medicare and unemployment insurance (though this also means that you could potentially get smaller monthly Social Security checks once you retire).
In rare situations, employers offer HSAs outside a Section 125 arrangement. Such an arrangement is more like a direct-deposit than a “payroll deduction,” even if it’s coming from your paycheck, because it’s coming out after your income and tax deductions are figured out. These types of contributions to HSAs are considered income, and as such, withholding and payroll taxes are calculated on the full amount you earn during each pay period.
However, you can deduct your total annual contributions on your tax return, regardless of whether you itemize deductions or take the standard deduction. Doing this might push you into a lower tax bracket, reducing your liability even further.
You can also make contributions directly to an HSA outside of your employer, either when you buy HDHP coverage on your own or use an HSA provider, a.k.a. an HSA custodian, other than the one your employer uses. In this case, you send contributions to your account after
your employer calculates withholding and payroll taxes on the full amount you earn during each pay period. You can still claim a deduction for your total annual contributions on your tax return, reducing your annual tax for the year — a good ol’ win-win!
Business Owners & Gig Worker Contributions
If you are a business owner or gig worker, you can still contribute to an HSA if you have a qualifying HDHP and no other health insurance coverage. You can deduct your total annual contributions on your tax return, but you will still have to pay the same amount of self-employment tax to cover Social Security and Medicare taxes.
It’s Like Nike Says…
When it comes to an HSA, just do it. As long as you’re eligible (thanks, HDHP!), no matter how your account is structured, it’s worth your while. You can take advantage of other tax benefits that enable your HSA to double as a retirement account
, which is a serious plus.
While you’ll never pay taxes on distributions for medical expenses, if you take money out for other reasons before you turn 65, you will be taxed
, and hit with a 20% penalty.
After 65 you can use all those lovely investment returns within your account as an additional source of income (and while you will be taxed, the penalty will be waived!)
The Long & The Short of It
At Starship, we’re here to help you understand why HSAs are the wealth-building tool
you probably didn’t even know existed … and we’re indebted to helping you build yourself up, one tax-advantage at a time. Keep checking back for more HSA tips, tricks, and news! We’ll be here.