Time for Employers to Match Popular Retirement Contribution Approach

Many companies offer matching contributions to encourage employees to stretch to contribute more to their retirement plans. Why not the same strategy for Health Savings Accounts?

Since the introduction of defined-contribution retirement plans in the workplace more than four decades ago, employers have understood the benefits of supplementing employee savings. Most have settled on the concept of matching contributions in which the company offers to deposit a variable amount (usually expressed as a percentage of annual income, up to a limit) of money into each employee's account.

That same logic can help employees fund their Health Savings Account to build an emergency medical fund and save for retiree medical expenses. Yet few employers adopt this approach. Most should.

Why Should Employers Encourage Contributions?

Employers have several reasons to establish a company-contribution program and encourage employees to fund their Health Savings Accounts:

• When workers have a choice between two or among three or more medical plans, the more cerebral employees will look at the difference in premium from plan to plan and employer assistance in the form of a Health Reimbursement Arrangement or contributions to a Health Savings Account. If employers don't close or eliminate the difference in out-of-pocket costs among plan with these tools, employees won't enroll in plans with higher deductibles.
• Employee satisfaction with their medical coverage increases when they have the financial resources to cover their out-of-pocket expenses. Employers should do everything that they can to encourage employees to fund their accounts.
• The pandemic has heightened employees' angst over financial matters, and survey after survey shows that they're looking to their company to provide education and direct support. Employee matching contributions constitute financial support.

In short, it's in the company's interest to have employees who feel more financially secure. That state results in less productive time lost to worrying about finances, less financial stress that often manifests itself in physical symptoms (decreasing productivity and increasing levels of both absenteeism and medical claims), and less loyalty to the company.

What's the Benefit to Matching Contributions?

Most employers who contribute to employees' retirement account offer some form of matching contribution. The rationale is simple: Employees are more likely to fund their retirements more aggressively when they can earn "free money" by contributing.

Example: The company provides a dollar-for-dollar match in the first 3% of income contributed to the retirement account, then a 50% patch on the next 4% of income. A worker earning $50,000 enjoys a 100% return on the first $1,500 that she contributes. If she contributes another $2,000 (4%), she can claim an additional $1,000 from her employer. The net result: Her $3,500 of payroll deductions (7% of her gross income) becomes a total contribution of $6,000 annually.

Employees with short time horizons are less likely to look far enough into the future to fund their retirement accounts at appropriate levels. Employer matching contributions push workers to contribute more than they otherwise would by dangling the carrot of matching contributions.

Are Health Savings Account Matches Permitted?

Yes and no. Yes, they are permitted - but only when contributions go through a Cafeteria Plan. When employees can make pre-tax contributions to their accounts, the contributions must go through a company's Cafeteria Plan. In that case, employer contributions are governed by Cafeteria-Plan rules as well, which means that those employers can offer a matching contribution.

Rare is the employer who doesn't permit workers to fund their accounts through pre-tax payroll deductions, since companies aren't assessed payroll taxes on those contributions. Thus, nearly every company offering a Health Savings Account program today can restructure their contribution program to permit matching. And those that don't have a Cafeteria Plan today have the option to adopt one.

What Is the Ideal Match Strategy?

The structure of the match is meaningful. Let's say an employer is willing to deposit up to $1,500 (self-only) or $3,000 (family) to employees' Health Savings Accounts. Today, companies usually simply give those funds to workers either as a lump-sum contribution or as periodic (semi-annual, quarterly, or per pay period) deposits into their accounts. This approach does nothing to encourage employees to make additional pre-tax payroll deposits, since there is no carrot.

Here are two distinct designs that an employer can offer to encourage employees to contribute:

1. Dollar-for-dollar match of the first $1,500/$3,000 of contributions. This way, accounts are funded to $3,000/$6,000 if employees take full advantage of the instant 100% return on investment by claiming the full match.
2. Dollar-for-dollar match of the first $500/$1,000, then a 60% match of the next $1,250 (total $750 match)/$2,500 (total $1,500 match). Total contributions to capture the full match: $2,000 employee (plus $1,500 employer, for a total of $3,500 deposited) for self-only coverage. Double that figure for an employee enrolled in a family plan. Employees who receive the full employer contribution receive a 71% match, rather than 100%, but end up with higher balances and lower taxable incomes than workers in Scenario 1 who contribute only to the match limit.

Either approach has a positive effect on total balances for employees who are committed to capturing every dollar that the employer offers. The first is easier to understand and offers a 100% match of all employee contributions. Employers must account for most of the match offered in their budget. But total contributions fall short of the second approach.

In contrast, the second approach is more complex with two tiers of matches, but it results in higher total contributions (by $500 for self-only and $1,000 for family coverage) with no difference in the company's total commitment (maximum of $1,500/$3,000 in total company funds per employee). Fewer employees are likely to stretch to capture the full employer match because it's no longer a 100% match across the board. Employers can expect to pay out less in total contributions to employees' Health Savings Accounts because fewer workers will stretch for only a 60% match at higher levels of employee contributions.

Does Nondiscrimination Testing Apply?

All components (like Health FSA and Dependent Care FSA) of a Cafeteria Plan, as well as the Plan itself, must undergo annual nondiscrimination testing to ensure that benefits don't flow disproportionately to owners, senior executives, and highly paid employees. Employers can minimize this risk by keeping their contribution generous, as in the examples above. In contrast, a program that provides a 100% match on the next $1,000/$2,000 of contributions after the employee has contributed $1,500/$3,000 might fail this test. In this design, lower paid employees can't capture any employer matching contribution until they achieve a high level of payroll deductions.

Thus, it's important that the match start with the first dollar of employee payroll deductions and be rich enough that it's a meaningful incentive that will elicit the behavioral reaction sought (greater funding of the Health Savings Account) to pass nondiscrimination testing.

Beyond testing, though, companies should feel a moral tug to help their employees who are most vulnerable financially. Even absent testing, companies should design programs that encourage workers with lower incomes - those for whom stretching to fund their accounts is most painful - to build an emergency medical fund through their Health Savings Account.

The Bottom Line

Employers recognize the benefits of matching contributions in their retirement programs. But most don't look at Health Savings Accounts through the same lens. They should. Matching retirement contributions help employees enjoy a more secure retirement by increasing savings. Matching Health Savings Account contributions yield the same benefit - more savings - that employees can enjoy both today and years into the future.

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