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HSA Deductions from Severance Pay

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We have a former employer whose severance package includes payments over several years and health insurance. The employee has a HDHP and no other health insurance. Can they make HSA contributions through payroll deductions from their severance payments?

We are making all of the payroll tax withholding and basically treating the severance payments like wages except they are not for services rendered, so they are not eligible for our 401K plan.

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If your cafeteria plan so provides, you can permit the former employee to make HSA contributions from his or her severance payments on a pre-tax basis (assuming, of course, that the employee remains enrolled in a qualifying HDHP).  The employee can also pay the employee's share of the cost of coverage (whether through COBRA or through extended coverage) on a pre-tax basis from his or her severance pay as well, again, if the cafeteria plan so provides.

Of course, the amount of pay must be higher than the amount of the pre-tax payments in order for this to work.

Many cafeteria plans don't have this provision because, among other things, it increases the employer's administrative responsibilities.

Severance payments are generally considered W-2 wages, so you really can't treat them as anything else.

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