How to Set Up an HSA for Your Employees: HDHP, Payroll, and Rules

To set up an HSA for employees, offer a qualifying high-deductible health plan, confirm each employee meets the IRS eligibility rules, put a Section 125 cafeteria plan in place if you want pre-tax payroll deductions, choose a qualified custodian to hold the accounts, and connect the whole thing to your payroll system. The steps themselves are straightforward. The compliance rules around contributions, ERISA, and disqualifying coverage are where most employers get into trouble.

Step 1: Offer a Qualifying High-Deductible Health Plan

No employee can contribute to an HSA without HDHP coverage. For plan years beginning in 2026, the IRS requires:

A minimum annual deductible of $1,700 for self-only coverage and $3,400 for family coverage
A maximum annual out-of-pocket limit of $8,500 for self-only coverage and $17,000 for family coverage, counting deductibles, copays, and coinsurance but not premiums

These figures come from IRS Revenue Procedure 2025-19 and adjust each year for inflation, so check the updated numbers before every open enrollment.¹

The out-of-pocket maximum applies only to in-network services when the plan uses a provider network.² Review the Summary of Benefits and Coverage before enrollment to confirm the plan carries an official HDHP designation and doesn’t provide first-dollar coverage for anything beyond preventive care. A plan that covers doctor visits or prescriptions at a flat copay before the deductible is met will likely disqualify the entire arrangement.

One 2026 expansion is worth flagging. Under the One Big Beautiful Bill Act, bronze-level and catastrophic plans available through a Health Insurance Exchange now automatically qualify as HDHP-compatible even if they don’t meet the standard thresholds, and IRS Notice 2026-05 clarifies that this treatment applies whether or not the plan was actually purchased through an Exchange.³⁴ The same law made the telehealth-before-deductible exception permanent and lets employees in qualifying direct primary care arrangements contribute to an HSA.

Step 2: Confirm Which Employees Are Actually Eligible

Offering an HDHP is necessary but not sufficient. Each employee has to individually qualify. Under Section 223 of the Internal Revenue Code, an eligible individual must:⁵

Be covered under an HDHP on the first day of the month
Not be covered by other disqualifying health insurance, including a spouse’s non-HDHP plan
Not be enrolled in any part of Medicare
Not be eligible to be claimed as a dependent on someone else’s tax return

The Medicare rule catches employers off guard. An employee over 65 who has enrolled in Medicare Part A or Part B cannot contribute to an HSA even if they are also enrolled in your HDHP. They can still spend existing balances tax-free, but no new contributions are allowed for any month they have Medicare coverage.

Disqualifying coverage is the other common trap. A general-purpose Flexible Spending Account or Health Reimbursement Arrangement that reimburses medical expenses before the HDHP deductible is met will disqualify the employee. The workaround is a limited-purpose FSA, which restricts reimbursement to dental and vision expenses only.⁶ If you offer both an HSA and an FSA, structure the FSA as limited-purpose so employees don’t accidentally lose eligibility.

Step 3: Set Up a Section 125 Cafeteria Plan for Pre-Tax Deductions

If you want employees to contribute to their HSAs through pre-tax payroll deductions, you need a Section 125 cafeteria plan. It’s a written plan document that lets employees choose between taxable cash compensation and certain pre-tax benefits, including HSA contributions by salary reduction.⁷

Without this plan, employee payroll deductions go into the HSA with after-tax dollars. The employee can still claim a deduction on their personal return, but they’ll owe FICA (Social Security and Medicare) taxes on those amounts, and you’ll owe the matching employer FICA share. Running contributions through Section 125 eliminates both.

If you already have a cafeteria plan for dental or vision premiums, you’ll need a plan amendment to add the HSA option. Most payroll providers and benefits attorneys can supply template language. One compliance consequence to note now: routing employer contributions through a Section 125 plan replaces the HSA comparability rules with Section 125 non-discrimination testing. Both are covered below.

Step 4: Choose a Custodian and Open the Accounts

HSA funds must be held by a qualified trustee or custodian, typically a bank, credit union, or specialized HSA administrator. You’ll sign a participation agreement that sets up an administrative portal, defines account fees, and specifies how contributions are transferred. Compare per-account monthly charges, investment platform options, and payroll integration before committing.

To open each account, collect the employee’s full legal name, Social Security number, date of birth, and residential address during open enrollment. Most custodians provide a secure upload for batch processing, and setup typically takes five to ten business days depending on volume.

One timing detail is easy to miss: employees can only receive tax-free reimbursement for medical expenses they incur after their HSA is established, and state law determines the exact establishment date.² If there’s a gap between when HDHP coverage starts and when the HSA accounts are actually opened, medical expenses during that gap aren’t eligible for tax-free reimbursement. Coordinate your timeline so accounts are funded on or before the HDHP effective date.

Step 5: Connect Payroll and Handle W-2 Reporting

Once accounts are open, integrate the custodian with your payroll system so pre-tax deductions flow automatically each pay period. Most major payroll providers have direct connections with the larger HSA custodians. The automation is worth the setup effort because it eliminates the manual errors that lead to over-contributions and incorrect tax reporting.

At year-end, all HSA contributions made through payroll, both employer and employee portions, are reported as a single combined amount on the employee’s Form W-2 in Box 12 using Code W.⁸ This is separate from the Code DD reporting for the overall cost of employer-sponsored health coverage.⁹ The Code W amount reduces the employee’s maximum allowable contribution for the year.

Have HR monitor the first funding cycle to make sure the amounts hitting each account match what was withheld from paychecks.

Employer Contribution Limits and Comparability Rules

You are not required to contribute to employee HSAs, but many employers do. For 2026, combined employer and employee contributions cannot exceed $4,400 for self-only HDHP coverage or $8,750 for family coverage.¹ Employees aged 55 or older who are not enrolled in Medicare can contribute an additional $1,000 catch-up.²

When employer contributions are made outside a Section 125 cafeteria plan, the comparability rules under Section 4980G apply. You must contribute the same dollar amount, or the same percentage of the HDHP deductible, to all comparable participating employees, meaning everyone in the same employee category with the same type of coverage.¹⁰ You do not have to contribute the same amount across coverage categories. Contributing $1,000 to every employee with family coverage and nothing to employees with self-only coverage is permitted.

Violating comparability triggers an excise tax equal to 35% of the total amount contributed to all employee HSAs during that calendar year, not just the non-comparable portion.¹¹¹² That penalty is steep enough to justify monthly tracking of contribution records.

If contributions run through a Section 125 cafeteria plan instead, the comparability rules don’t apply. The plan is subject to Section 125 non-discrimination testing, which prevents disproportionate benefits from going to highly compensated or key employees.¹³ Most third-party administrators run this testing annually.

Keep the HSA Program Outside ERISA

An employer-sponsored HSA program can fall under ERISA, which would require annual Form 5500 filings, a formal Summary Plan Description, and fiduciary duty standards.¹⁴ Most employers want to avoid that. The Department of Labor’s safe harbor keeps your program outside ERISA as long as all of these conditions are met:¹⁵

Employee participation is completely voluntary
You don’t limit employees’ ability to move their HSA funds to a different custodian
You don’t influence investment decisions on the funds in the accounts
You don’t represent the HSA as an employer-maintained employee welfare benefit plan
You don’t receive any payment or compensation from the HSA custodian in connection with the accounts

That last condition is the one that catches people. If your custodian offers you a discount on another banking product as an incentive for bringing them the HSA business, it counts as compensation and can push the program into ERISA territory. Keep the custodian relationship at arm’s length.

What Happens When an Employee Leaves

The HSA belongs to the employee, not the company. When someone leaves through resignation, termination, or retirement, the account and every dollar in it goes with them.² You stop making payroll contributions on their last day, but you have no right to claw back employer contributions already deposited. The former employee can keep the account at your custodian, roll it to a different one, or spend the balance on qualified medical expenses, including COBRA premiums.

An employee who loses HDHP coverage after leaving can no longer make new contributions, but they can spend the existing balance tax-free on qualified medical expenses indefinitely. Balances roll over year to year for the life of the account.

State Income Tax Differences

HSA contributions are tax-free at the federal level, but not every state follows the federal treatment. California and New Jersey both tax HSA contributions as regular income for state tax purposes. A handful of other states tax HSA investment earnings under certain conditions. If you have employees in either California or New Jersey, make sure your benefits communications reflect the difference so no one is surprised at tax time.

1
Internal Revenue Service. Revenue Procedure 2025-19
2
Internal Revenue Service. Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans
3
Internal Revenue Service. Treasury, IRS Provide Guidance on New Tax Benefits for Health Savings Account Participants Under the One Big Beautiful Bill
4
Internal Revenue Service. IRS Notice 2026-05
5
Internal Revenue Service. Individuals Who Qualify for an HSA
6
FSAFEDS. Limited Expense Health Care FSA
7
Internal Revenue Service. FAQs for Government Entities Regarding Cafeteria Plans
8
Internal Revenue Service. HSA Contributions
9
Internal Revenue Service. Form W-2 Reporting of Employer-Sponsored Health Coverage
10
eCFR. 26 CFR 54.4980G-4 – Calculating Comparable Contributions
11
Office of the Law Revision Counsel. 26 USC 4980E – Failure of Employer to Make Comparable Archer MSA Contributions
12
eCFR. 26 CFR 54.4980G-1 – Failure of Employer to Make Comparable Health Savings Account Contributions
13
eCFR. 26 CFR 54.4980G-5 – HSA Comparability Rules and Cafeteria Plans
14
U.S. Department of Labor. Plan Information
15
U.S. Department of Labor. Field Assistance Bulletin 2006-02