If an employer provides an HSA and the employee contributes to the HSA through payroll deduction, then in addition to HSA contributions being tax deductible for federal income tax purposes (and most state income tax purposes), the contributions are also deductible from payroll taxes, Social Security and Medicare. Currently Social Security is taxed at 6.2% and Medicare at 1.45%, for a total of 7.65%. This deduction is not available to those of us who fund our own HSA and are not provided one by our employer.
While saving an extra 7.65% on taxes seems like a good deal, and it may be, to determine so takes some calculations. Since the HSA contribution is being deducted from Social Security earnings, then Social Security benefits will be reduced as well. Is it worth it to save a maximum of $501 for a family plan, or $252 for an individual plan per year?
Social Security benefits (including disability and survivor benefits) are based on earnings. For retirement benefits the highest 35 years of earnings are indexed for inflation and divided out to come up with your average indexed monthly earnings. This number is then applied to the Social Security bend points.
In 2014 these bend points are $816 and $4,197.
The first $816 of AIME are multiplied by 90%
Then $817 to $4197 of AIME is multiplied by 32%
Everything above $4,197 is multiplied by only 15%
The total of these numbers is your Primary Insurance Amount. For workers who project their AIME will be under $4,197 I would caution against taking the social security deduction and would instead recommend contributing to an HSA on your own instead of through the employer contribution.
For someone with an AIME of let’s say $4,000, contributing the max to an HSA family plan over 35 years reduces their AIME to $3,454. An AIME of $4,000 results in a PIA of $1,752. An AIME of $3,454 would result in a PIA of $1,578 – a loss of retirement income of $174 per month, or $2,088 per year, or 9.8% of SS Income.
For someone with an AIME of $5,000 contributing the max to an HSA family plan over 35 years reduces their AIME to $4,454. An AIME of $5,000 results in a PIA of $1,936. An AIME of $4,454 would result in a PIA of $1,854 – a loss of retirement income of $82 per month, or $984 per year, or 4.2% of SS Income .
The results are disastrous for someone who dips into the first bend point. Most likely this would only occur if the lower earner in a couple was offered an HSA through work while the higher earner did not have this option.
For someone with an AIME of $1,000 contributing the max to an HSA plan over 35 years reduces their AIME to 454. An AIME of $1,000 would result in a PIA of $793. An AIME of $454 would result in a PIA of $408 – a loss of $385 per month, or $4,620 per year, or 49% of SS Income.
While in this scenario the lower earner could possibly receive spousal retirement benefits, they very likely would be less than what her own benefit would be. Taking the payroll tax deduction for an HSA ONLY makes sense for those with lifetime earnings that will exceed the second bend point in the Social Security formula. The rest of us should avoid this and fund our own HSA. I recommend using HSA Administrators.
NOTE: It is okay to allow an employer to contribute to your HSA for you, some employers will fund an HSA as an employee benefit. This will not count against your Social Security earnings.