Why You Should Open an HSA Before You Start Your Payroll Deductions

You might be surprised to know that it is a common problem that organizations start deducting payroll contributions, elected by employees with the intent of placing them in their Health Savings Account (HSA), before the account actually exists. There are several reasons why this happens and two viewpoints to consider: the employee’s and the employer’s. In this post, we’ll take a look at why it is a problem from the employee’s perspective.

As an employee, you may not know that it is your responsibility to open the HSA because it is a personal financial account owned by you, not your employer.  It’s an easy detail to miss, especially considering this is not true for Flexible Spending Arrangements (FSAs), Health Reimbursement Arrangements (HRAs), and even 401(k) account setup.

Also, the U.S. Patriot Act requires that all holders of personal financial accounts be verified, so the bank may ask to see identity documents or receive a signature. This verification step confuses many employees and sometimes cause accounts to never be opened, meaning the HSA is never legally established.

Often, employers provide information about your health plan options in large paper packets or on your company Intranet. You may have overlooked or not understood the HSA benefits and options due to the amount of material covering other aspects of your health plan benefits. You were likely asked to choose a payroll contribution amount to be deposited in your HSA before you’ve finished opening it.

A common result is that employers deduct HSA contributions from paychecks when an HSA doesn’t exist to receive the deposit. This has practical administrative impacts and tax, legal and compliance consequences for both employees and employers:

What Are the Potential Consequences of This Problem to You As an Employee?

  1. No access to funds. The most obvious problem with having a payroll deduction and no HSA is that the funds have nowhere to go. You will see a deduction on your pay stub but have no immediate means of retrieving the funds.  Whether you need those funds for routine qualifying medical expenses or in an emergency, you have no access to your funds nor a quick way of gaining access.
  2. Inaccurate income tax filing. When it is time to file taxes, the information on your W-2 form provided by the employer indicates funds as going into an HSA pre-tax, which means lower stated federal taxes paid for the year. This will result in inaccurate tax reporting since the funds are actually not in an HSA.
  3. Loss of favorable tax treatment on medical expenses. Only medical expenses incurred after the HSA establishment date can be paid or reimbursed from an HSA. So if your HSA is not fully established, your medical expenses are not tax-free even if money is being deducted from your paycheck. If your HSA is not completely open, money being deducted by your employer may be being sent to a bank “suspense account” and by the time you finally do open the HSA, any medical expenses made in the interim do not qualify for pre-tax treatment, meaning you effectively lost a 25+% savings opportunity on them.
  4. Future ineligibility to contribute already-deducted funds. If you discover the error, but have since had changed your insurance selection to a non-High Deductible Health Plan (HDHP), then you are no longer eligible to open an HSA and deposit the withheld contributions, causing paycheck corrections or even more difficult adjustments if you’ve left the company.

How to Fix the Problem

If you don’t have an open HSA, contact your HR Department to determine where and how you can open the account as soon as possible.  Once the HSA is established, inform HR or payroll administration so they can initiate any catch-up funding from amounts deducted from payroll but not yet deposited.

If you are unable or no longer qualified to open an HSA account, your finance department will need to reimburse you for funds withheld from your paycheck adjusted for taxes owed.

Keep in mind that catch-up funding will not be an option if the funds are from the previous year and the tax filing deadline has passed and/or you have changed to a non-HDHP insurance plan.

Lastly, if you claimed the deduction on your taxes based on your W-2, you will want to consult a tax advisor to file an amendment. You will still need to work with your employer because you’ll need an adjusted W-2.

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