ComplyDIY · BenefitLab

At-a-Glance What this is, who it affects, when to set it up, and the risk.−

What An employee-owned savings account for qualified medical expenses, paired with an HSA-eligible HDHP. The annual contribution limit is $4,400 (self-only coverage) or $8,750 (family coverage) for 2026, rising to $4,500 and $9,000 for 2027, plus a $1,000 catch-up for employees age 55 and older. Funds roll over year to year with no use-it-or-lose-it rule. Accounts are held by an outside bank or HSA custodian, not by the employer.

Who Employees enrolled in an HSA-qualified HDHP (minimum deductible: $1,700 self-only / $3,400 family for 2026, $1,750 / $3,500 for 2027; OOP max: $8,500 / $17,000 for 2026, $8,700 / $17,400 for 2027), not enrolled in any disqualifying coverage (general-purpose FSA or HRA, Medicare), and not claimed as another person's tax dependent. Starting January 1, 2026, employees enrolled in bronze or catastrophic Exchange plans and certain direct primary care arrangements may also be eligible.

When Employees open their HSA at HDHP enrollment. If you offer pre-tax payroll contributions through Section 125, employees may change their contribution amount at any time, at least monthly, without a qualifying event. This is different from FSA elections, which are generally irrevocable for the year.

Risk Contributing to ineligible employees (e.g., those on Medicare or with a general-purpose FSA); no Section 125 plan in place for pre-tax payroll; skipping nondiscrimination testing; failing comparability rules when contributing outside Section 125; or allowing a disqualifying FSA/HRA design alongside the HDHP.

Deadlines & Frequency Key timing for setup, contributions, and annual compliance.+

$4,400

2026 self-only limit

Family limit is $8,750. For 2027: $4,500 self-only / $9,000 family. Catch-up is $1,000 at age 55 and older for both years.

Monthly

Election changes

The Section 125 plan must let employees change HSA contributions at least monthly, prospectively.

Annual

Section 125 testing

If offering HSA salary reductions through a cafeteria plan, run the three Section 125 tests each year.

Trigger	When	Notes
Section 125 cafeteria plan in place (if offering pre-tax payroll)	Before first pre-tax deduction	A POP is sufficient if you don't already have one. The plan document must exist before any pre-tax payroll deduction is taken. If you already have a POP or FSA plan, HSA contributions can be added as an amendment.
HSA custodian agreement	Before first employer or employee contribution	Select and contract with a bank, credit union, or other IRS-approved HSA custodian. Employer funds go to the custodian, not held by the employer.
Employee HSA enrollment	At HDHP eligibility	Confirm no disqualifying coverage (general-purpose FSA/HRA, Medicare) before opening or funding the account.
Employee contribution elections and changes	At least monthly (any time, prospectively)	Unlike FSAs, HSA salary reduction elections are not irrevocable. The Section 125 plan must allow employees to start, stop, increase, or decrease their HSA contribution at least monthly, for any reason, effective prospectively.
Contributions (employee and employer)	Any time during plan year; through tax filing deadline for prior year	Employees may continue contributing to the prior year's limit through the tax filing deadline (generally April 15). Pro-rate for mid-year HDHP eligibility; apply the last-month rule carefully.
Nondiscrimination testing (Section 125)	Annually; mid-year recommended	If offering HSA salary reductions through a Section 125 cafeteria plan, the plan must pass the three Section 125 nondiscrimination tests annually. No IRS filing required, internal test only. Mid-year testing allows time for corrections.

Trigger: Section 125 cafeteria plan in place (for pre-tax payroll)

When: Before first pre-tax deduction

Notes: A POP is sufficient. Existing POP/FSA plans can add HSA contributions by amendment.

Trigger: HSA custodian agreement

When: Before first contribution

Notes: Contract with an IRS-approved custodian. The employer does not hold the funds.

Trigger: Employee HSA enrollment

When: At HDHP eligibility

Notes: Confirm no disqualifying coverage before opening or funding the account.

Trigger: Contribution elections and changes

When: At least monthly, prospectively

Notes: HSA elections are not irrevocable; employees can change any time for any reason.

Trigger: Contributions (employee and employer)

When: Through the prior-year tax filing deadline

Notes: Generally April 15. Pro-rate for mid-year eligibility; apply the last-month rule carefully.

Trigger: Nondiscrimination testing (Section 125)

When: Annually; mid-year recommended

Notes: Three Section 125 tests if HSA salary reductions run through a cafeteria plan.

What You Need: Docs & Data Lighter paperwork than an FSA, but the setup choices matter.+

HDHP plan documentation: Confirmation that your health plan qualifies as an HSA-eligible HDHP: minimum deductible of $1,700 (self-only) or $3,400 (family) for 2026, rising to $1,750 / $3,500 for 2027, and OOP maximums no higher than $8,500 / $17,000 for 2026, $8,700 / $17,400 for 2027. Get this from your carrier or TPA.
HSA custodian agreement: A contract with a bank, credit union, or other IRS-approved HSA custodian who will hold and administer the accounts. The employer cannot serve as the HSA trustee or hold employee HSA funds. Most carriers, payroll platforms, and benefits TPAs offer an integrated custodian or can recommend one.
Section 125 cafeteria plan document: Required before any employee can make pre-tax HSA payroll contributions. A POP is sufficient; if you already have a POP or FSA plan, add HSA salary reductions as a formal amendment. Without a Section 125 plan, employee payroll contributions are after-tax (deductible on their personal return, but the employer and employee both pay FICA on them).
FSA/HRA compatibility documentation: If you also offer an FSA or HRA, confirm it is HSA-compatible: limited-purpose (dental/vision only), post-deductible, or retiree-only. A general-purpose FSA or HRA disqualifies employees from contributing to an HSA.
Employer contribution policy: Document contribution amounts, coverage tier eligibility, proration for mid-year enrollees, and pay frequency. If contributing outside Section 125, confirm your approach satisfies comparability rules by tier.
Employee census (for NDT): A roster of all employees with compensation, ownership, officer status, HDHP enrollment, and HSA election amounts, needed to run the Section 125 nondiscrimination tests annually. See the Templates & Resources section below.
Payroll and custodian setup: Configure payroll to send pre-tax deductions and employer contributions to the HSA custodian each pay period. Establish a corrections workflow for returned or reissued contributions.

How To Do It: Step-by-Step Follow this sequence to keep contributions compliant from day one.+

Part A: Initial Setup

1

Set up the Section 125 cafeteria plan, or amend an existing oneIf you want employees to make pre-tax HSA payroll contributions, a Section 125 plan must be in place before the first deduction. A POP is the simplest option if you don't already have one. If you have an existing FSA or POP plan document, add HSA salary reductions via a formal written amendment. A TPA can draft the document or amendment if needed.

2

Select and contract with an HSA custodianChoose a bank, credit union, or other IRS-approved entity to hold and administer the accounts. Most payroll platforms, benefit administrators, and carriers offer integrated HSA custody. Confirm the custodian can accept your payroll file format and establish the contribution transfer process before the first pay period.

3

Confirm HDHP eligibility and remove disqualifying coverageVerify your health plan meets the HDHP definition (2026: minimum deductible $1,700/$3,400, OOP max $8,500/$17,000; 2027: minimum deductible $1,750/$3,500, OOP max $8,700/$17,400). If you offer an FSA or HRA, confirm it is HSA-compatible: limit it to dental and vision (limited-purpose) or post-deductible if needed. A general-purpose FSA disqualifies employees from HSA eligibility on day one of the plan year.

4

Choose your employer contribution approachIf contributing employer funds through the Section 125 cafeteria plan, follow cafeteria plan nondiscrimination rules (not comparability). If contributing directly outside Section 125 (e.g., via a separate deposit), comparability rules under Section 4980G apply: you must contribute the same dollar amount or percentage of the deductible to all comparable participants, by coverage tier, within each comparable period.

5

Configure payroll for monthly elections and custodian transfersSet up pre-tax deductions and employer contributions to flow to the HSA custodian each pay period. Importantly, the Section 125 plan must allow employees to start, stop, increase, or decrease their HSA contribution election at least monthly, for any reason, effective prospectively. This is different from FSA elections; there is no irrevocable-election rule for HSA contributions under Section 125.

Part B: Annual Compliance

1

Run nondiscrimination testing annuallyBecause HSA salary reductions run through a Section 125 cafeteria plan, that plan must pass the three Section 125 nondiscrimination tests each year: the Eligibility Test, the Benefits & Rights Test, and the Key Employee Concentration Test. Use the Section 125 NDT Worksheet on the FSA page as a reference; substitute HSA election amounts for FSA amounts in the census. Run tests mid-year if possible so you have time to correct issues before year-end.

2

Monitor eligibility status changesEmployees lose HSA eligibility when they enroll in Medicare, elect a general-purpose FSA (theirs or their spouse's), or drop HDHP coverage. Stop contributions promptly when eligibility ends; continuing to fund an ineligible employee creates a taxable event for them.

3

Educate employees annuallyCover: eligible expenses, the rollover benefit (no use-it-or-lose-it), investment options, the contribution limit for the year, what breaks eligibility (Medicare, general FSA, dropping the HDHP), and the post-age-65 rules. Well-educated employees avoid the most common HSA mistakes.

4

Close out the yearReconcile Box 12, Code W totals (employer contributions plus Section 125 employee contributions) for W-2 reporting. Confirm contribution amounts stayed within the annual limits. Retain NDT workpapers and all election records.

Delivery Rules How contributions flow, who holds the money, and what drives tax treatment.+

Pre-tax payroll requires a Section 125 cafeteria plan: Employee HSA contributions made through payroll are only pre-tax if routed through a valid Section 125 cafeteria plan. Without Section 125, payroll deductions are after-tax; employees can still deduct them on their personal tax return as an above-the-line deduction, but both employer and employee pay FICA on them. Setting up Section 125 saves both parties money.
Monthly election changes required: When HSA contributions run through Section 125, the plan must allow employees to change their election amount at least monthly, for any reason, effective prospectively. Employees do not need a qualifying event to change their HSA contribution; this is explicitly different from the irrevocable election rule that applies to FSA and other cafeteria plan benefits.
Contributions go to the custodian, not the employer: All HSA contributions, employer and employee, must be deposited directly into the employee's HSA account at the outside custodian. The employer cannot hold, pool, or manage HSA funds. Keep payroll transfer timing consistent and documented each pay period.
Employer contributions outside Section 125, comparability rules: If the employer contributes directly (not through payroll deduction and not through a Section 125 plan), Section 4980G comparability rules apply. The employer must contribute the same dollar amount or the same percentage of the HDHP deductible to all comparable employees within a comparable period. Failure triggers a 35% excise tax on the amount contributed to all HSA participants. Routing all contributions through Section 125 avoids comparability entirely.
Age-55 catch-up: The additional $1,000 catch-up contribution must go to the employee's own HSA, not a spouse's, even if both spouses are age 55 or older and on the same family HDHP. Each spouse must have their own HSA to each make a catch-up contribution.
W-2 reporting, Box 12, Code W: Report the total of employer HSA contributions and employee Section 125 salary reductions in Box 12, Code W on the employee's W-2. This includes amounts contributed by the employer and amounts withheld from the employee's pay under the Section 125 plan, but not after-tax employee contributions made outside Section 125.

Proof & Recordkeeping What you need if the IRS questions the tax treatment of contributions.+

Section 125 plan document and amendmentsThe signed cafeteria plan document (or POP amendment) authorizing HSA salary reductions, dated before the first pre-tax deduction. Retain indefinitely.
Employee election recordsA log of each employee's HSA contribution election by month, including starts, stops, increases, and decreases, with the effective date of each change. Because elections can change monthly without a qualifying event, the log must reflect the actual election in effect each pay period. Retain for at least 6 years.
HDHP enrollment and eligibility confirmationsDocumentation that each contributing employee was enrolled in an HSA-qualified HDHP for the period contributions were made, and was not enrolled in disqualifying coverage. Retain for at least 6 years.
Employer contribution policyThe written policy specifying contribution amounts by coverage tier, proration rules for mid-year enrollees, and timing. If contributing outside Section 125, retain documentation showing comparability compliance by tier and period.
Custodian deposit recordsPayroll reports and custodian confirmations showing each contribution by employee, pay period, and amount (employer vs. employee, if split). Retain for at least 6 years.
Nondiscrimination testing workpapersA written record of each year's Section 125 test calculations: employee census, HCI classifications, HSA election amounts, and pass/fail results for all three tests. Retain for at least 6 years.
W-2 Box 12, Code W reconciliationYear-end reconciliation of total employer and Section 125 employee HSA contributions reported in Box 12, Code W for each participant. Retain with payroll records.

Common Traps & FAQs The mistakes employers make most often, and quick answers.+

Common traps

No Section 125 plan before taking pre-tax deductions: Withholding employee HSA contributions from payroll on a pre-tax basis without a valid Section 125 cafeteria plan in place is an IRS compliance failure. The contributions become taxable wages, meaning both employer and employee owe FICA, and the employer may owe back taxes and penalties. Get the plan document (or amendment) signed before the first deduction.

Not allowing monthly election changes: When HSA contributions run through Section 125, the plan must allow employees to change their contribution amount at least monthly, for any reason. Restricting changes to annual open enrollment, or requiring a qualifying event to change HSA elections, violates the Section 125 regulations for HSA contributions. Audit your enrollment platform and plan document to confirm this flexibility is built in.

Skipping nondiscrimination testing: The Section 125 cafeteria plan that includes HSA salary reductions must pass three annual nondiscrimination tests. Many employers who add HSA contributions to an existing POP don't realize the testing obligation follows the plan. If the Key Employee Concentration Test fails, key employees lose the pre-tax exclusion on their HSA contributions.

Offering a general-purpose FSA alongside an HDHP: An employee covered by a general-purpose health FSA (theirs or their spouse's) is not eligible to contribute to an HSA, even if enrolled in an HDHP. If you offer both, the FSA must be limited-purpose (dental and vision only) to preserve HSA eligibility. Misconfiguring this disqualifies employees without them realizing it.

Funding employees after Medicare enrollment: Employees lose HSA eligibility the month they enroll in Medicare. Watch for retroactive Part A coverage, which occurs automatically when employees delay Social Security past age 65; Medicare Part A can be backdated up to 6 months, creating a retroactive disqualification. Contributions made during a retroactively ineligible period are taxable to the employee.

Holding HSA funds in an employer account: Employer and employee HSA contributions must be deposited into the employee's individual HSA at the outside custodian, not pooled in an employer account pending transfer. Delayed or improper transfers create both a compliance issue and a loss of the employee's investment earnings.

FAQs

Does our health plan qualify as an HDHP?

Check the IRS thresholds for the plan year. For 2026: the minimum annual deductible must be at least $1,700 (self-only) or $3,400 (family), and the annual out-of-pocket maximum cannot exceed $8,500 (self-only) or $17,000 (family). For 2027 (per Rev. Proc. 2026-24): minimum deductible of $1,750 / $3,500, and out-of-pocket maximums no higher than $8,700 / $17,400. Your carrier or TPA can confirm HDHP qualification. Starting January 1, 2026, bronze and catastrophic Exchange plans are also HSA-compatible under the One Big Beautiful Bill, even if they don't technically meet the traditional HDHP definition.

What's the difference between routing through Section 125 vs. making direct employer contributions?

Routing both employer and employee contributions through the Section 125 cafeteria plan means the employer follows Section 125 nondiscrimination rules, not Section 4980G comparability rules, and both employer and employee contributions are FICA-exempt. Direct employer contributions made outside Section 125 must satisfy strict comparability rules (same dollar amount or percentage of deductible by coverage tier, within each comparable period), and failure triggers a 35% excise tax. Most employers prefer the Section 125 route for this reason.

What if an employee uses HSA funds for a non-qualified expense?

The amount is included in the employee's taxable income for the year, and an additional 20% excise tax applies if the employee is under age 65. After age 65, non-qualified withdrawals are taxable as ordinary income but the 20% penalty no longer applies, making the HSA function like a traditional IRA for non-medical expenses at that point.

When is the annual contribution deadline?

Through the employee's tax filing deadline for the prior year, generally April 15 of the following year. Employees can designate a contribution as applying to the prior year if made before the filing deadline. Employer contributions generally must be made during the calendar year to apply to that year (unlike employee contributions).

Official Guidance & Links Primary source documents and IRS guidance for HSAs.+

26 U.S.C. Section 223: Health Savings Accounts (LII/Cornell). The statutory framework governing HSA eligibility, contribution limits, qualified medical expenses, and the rules for HDHP qualification.
IRS Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans. The IRS's plain-language guide covering HSA eligibility, contribution limits, qualified expenses, HDHP requirements, and how HSAs interact with FSAs and HRAs. Updated annually.
26 CFR 1.125-7: Cafeteria Plan Nondiscrimination Rules (eCFR). The regulatory text for the Section 125 Eligibility Test, Benefits & Rights Test, and Key Employee Concentration Test that apply when HSA contributions are offered through a cafeteria plan.
26 CFR 54.4980G-5: HSA Comparability Rules and Cafeteria Plans (LII/Cornell). The regulation explaining how comparability rules interact with cafeteria plan contributions, and why routing employer HSA contributions through Section 125 avoids the Section 4980G comparability requirement.
IRS Guidance: HSA Changes Under the One Big Beautiful Bill (2026). IRS guidance on the 2026 expansion of HSA eligibility to bronze/catastrophic Exchange plans and direct primary care arrangements under P.L. 119-21.

Special Cases & State Variations Where the standard rules work differently, including 2026 changes.+

2026 expansion, bronze and catastrophic Exchange plans: Starting January 1, 2026, employees enrolled in bronze-tier or catastrophic health plans available through an ACA Exchange are eligible to contribute to an HSA, even if the plan doesn't meet the traditional HDHP deductible definition. This significantly expands potential HSA eligibility for employers who offer Exchange-level coverage. Confirm HSA compatibility with your carrier.
2026 expansion, direct primary care (DPC) arrangements: Employees enrolled in a DPC arrangement (periodic fees up to $150/month for individuals, $300/month for families) are no longer disqualified from HSA contributions. Previously, DPC was considered "other coverage" that broke HSA eligibility. HSA funds can also be used tax-free to pay DPC fees starting in 2026.
Telehealth, permanently allowed pre-deductible: The One Big Beautiful Bill permanently allows HDHP plans to cover telehealth services before the deductible without disqualifying participants from HSA eligibility. This was a temporary rule that has now been made permanent for plan years beginning on or after January 1, 2025.
Spouse's general-purpose FSA: An employee whose spouse has a general-purpose health FSA is not eligible to contribute to an HSA, even if the employee is enrolled in the HDHP and doesn't participate in the spouse's FSA. Coordinate open enrollment messaging so employees understand this interaction and can make an informed choice.
Medicare enrollment timing: Contributions must stop the month before Medicare begins. Watch for retroactive Part A coverage; when an employee files for Social Security after age 65, Medicare Part A can be backdated up to six months. Contributions made during a retroactively disqualified period are taxable. Counsel employees approaching Medicare age to time their enrollment carefully.
Last-month rule: An employee who is HSA-eligible on December 1 may contribute the full annual limit for that year (rather than prorating). However, they must remain HSA-eligible through December 31 of the following year (the "testing period") or the excess contribution becomes taxable, plus a 10% penalty. This is an employee-side choice; make sure employees understand the risk before relying on it.
Simple Cafeteria Plan (Section 125(j)): Employers with 100 or fewer employees may elect Simple Cafeteria Plan status, which automatically satisfies all three Section 125 nondiscrimination tests. This applies to HSA salary reductions as well. See the POP page for eligibility details.
State income tax: Most states conform to federal HSA treatment, making contributions and earnings state-tax-exempt. California and New Jersey do not; HSA contributions are subject to state income tax in those states, and earnings are taxable. Confirm with your payroll provider if you have employees in those states.

Templates & Resources The Section 125 plan and NDT worksheet that support pre-tax HSA payroll.+

The Section 125 plan and NDT worksheet you need to support pre-tax HSA payroll contributions, both available on other pages since HSA shares the same Section 125 framework.

Section 125 Cafeteria Plan NDT Worksheet, FSA Page

When HSA salary reductions run through a Section 125 cafeteria plan, the plan must pass the same three Section 125 nondiscrimination tests as any other cafeteria plan benefit. Use the Section 125 FSA NDT Worksheet on the FSA page as a starting framework; substitute HSA election amounts for FSA amounts in the Employee Census tab. If your plan covers both an FSA and HSA salary reductions, test each benefit using the same census but separate election columns.

Section 125 Plan Document Template, POP Page

If you don't already have a Section 125 cafeteria plan in place, the plan document template is available on the Premium Only Plan (POP) page. To add HSA salary reductions, include them in the plan as a qualified benefit under Section 223, either in the original document or as a formal written amendment. The amendment must be signed before the first pre-tax HSA payroll deduction is taken.

These tools are for educational purposes and do not constitute legal or tax advice. Consult a qualified ERISA attorney or CPA before finalizing your plan document or relying on test results for tax reporting purposes.