Time Is Short to Review This Year's HSA Payroll Deduction

Take a careful look at how much you've contributed to your Health Savings Account this year. You may want to adjust your December payroll deduction.

It's not too late to fund your Health Savings Account for 2023. In fact, you can contribute up to Monday, April 15 - the due date of your 2023 federal income tax return.; Or maybe even later, if your region is struck by a natural disaster and the Internal Revenue Service extends the deadline.

But if you want to maximize your tax savings, you need to review your contributions to date and act quickly. Your deadline is rapidly approaching to adjust your payroll deductions.

Remember, your maximum contribution ($3,850 if you have self-only coverage or $7,750 if you're enrolled on a family plan, plus a $1000 catch-up contribution if you're age 55 or older) is tracked on the calendar year. That's true regardless of when your medical plan renews.

Two Ways to Fund Your Health Savings Account

You're not required to fund your Health Savings Account via pre-tax payroll deductions if your company offers this option through its Cafeteria Plan. Generally, though, it's a good idea. From a financial and tax perspective, it's usually the better way to contribute.

Pre-tax payroll deductions. Here are the financial and tax benefits of funding your account via payroll deductions:

1. No federal income taxes applied.

2. No state income taxes applied (except California and New Jersey don't allow a state income tax deduction).

3. No payroll taxes applied.

4. You enjoy the tax savings immediately (a $100 contribution to your Health Savings Account reduces your take-home pay by only about $70).

5. It's easier to fund a large purchase - a home, a college education, Christmas - with smaller, regular contributions rather than facing the full bill all at once.

Personal contributions. You make these deposits using funds from a personal checking or savings account. You still enjoy many, but not all, of the benefits that pre-tax payroll deductions offer when you include personal contributions as a deduction on your personal income tax return.

1. No federal income taxes applied. (Same)

2. No state income taxes applied (except California and New Jersey don't allow a state income tax deduction). (Same)

3. You've already paid federal payroll taxes, and your personal tax return doesn't include a mechanism to recover the payroll taxes paid on income that you earned and subsequently contributed to your Health Savings Account. Thus, you don't save $7.65 (for most owners) for every $100 that you contribute. That may seem like a small sum, but saving payroll taxes on $2,000 of contributions ($153 annually) at a 6% return generates an additional balance of $6,000 after 20 years and nearly $13,000 after 30 years.

4. You don't gain the tax benefit until you file your income tax return, which is often a lag of three months to more than a year. If you contribute $100 of personal funds in March 2023 and claim the deduction on your 2023 tax return, you won't receive your roughly $25 federal and state income tax savings until you file your tax return in the winter or spring of 2024.

5. If you don't set up regular transfers from your personal account to your Health Savings Account, you may find it difficult to find personal funds to contribute unless you receive a one-time windfall (like a bonus check) or draw down your emergency cash account.

The Importance of Timing

If you can make pre-tax contributions through payroll deductions, your employer must allow you to make prospective changes to your deduction amount at least monthly. If you want to contribute more before the end of the year, you need to act in November to change payroll deductions in December. And the sooner in November, the better, since the month ends quickly with the Thanksgiving holiday.

Example: You earned more than expected this year thanks to a bonus at work. You want to contribute an extra $1,000 to your Health Savings Account. You can prospectively increase your semi-monthly payroll deduction by an additional $500 per pay period to contribute through the Cafeteria Plan. You'll save an additional $76.50 (7.65% federal payroll tax) in taxes by contributing through the Cafeteria Plan rather than making a tax-deductible contribution from a personal account.

If you don't make the change before your company's deadline to adjust December's deductions, you may lose out on payroll-tax savings. If your company allows prospective changes that go into effect during the next payroll run (rather than at the beginning of the month only), you may be able to increase your payroll deduction in early December and have it take effect for some or all pay periods in the year's final month.

The Mechanics of Changing Payroll Deductions

Ask someone in your company's benefits office how to change your payroll deduction. Different firms have different processes. A few still require you to submit a paper form with your signature to make the change. Most accept changes only online, either through the company's payroll system or its Health Savings Account partners website.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.