HSA 125 Cafeteria Plan: How Pre-Tax HSA Payroll Works

Reviewed by a licensed benefits professional. Last reviewed: September 26, 2026.

An HSA 125 cafeteria plan is the setup that lets employees fund a health savings account with pre-tax payroll dollars, skipping both income tax and FICA. Without the cafeteria plan, an employee can still deduct HSA money on a tax return, but the 7.65% FICA savings for the employee and the employer are gone for good.

Most owners I talk to already offer a high-deductible plan and assume the HSA "just works." It works, but it often works after tax, because nobody wrote the HSA into a Section 125 plan document. That one gap can cost a 20-person company thousands of dollars a year in payroll tax.

Key facts (2026):

• HSA contribution limits are $4,400 for self-only and $8,750 for family coverage in 2026, rising to $4,500 and $9,000 in 2027 (IRS Revenue Procedure 2026-24, May 2026).
• HSA money an employee elects through a cafeteria plan is treated as an employer contribution and is generally not subject to employment taxes (IRS Publication 15-B, 2026).
• Employer and employee FICA are each 7.65% in 2026, so every pre-tax HSA dollar saves up to 15.3% in combined payroll tax (IRS Publication 15, 2026).
• Employees may start, stop, raise or lower HSA elections under a cafeteria plan at any time, as long as the change is prospective (IRS Notice 2004-50, Q&A 58).
• HSA money run through a cafeteria plan follows the Section 125 nondiscrimination rules, not the HSA comparability rules (26 CFR 54.4980G-5, 2006).
• Since January 1, 2026, bronze and catastrophic plans count as HSA-compatible (IRS Notice 2026-5, 2026).

What Is an HSA Cafeteria Plan?

An HSA cafeteria plan is a Section 125 cafeteria plan that includes health savings account contributions as one of its pre-tax benefits. Employees elect an amount, payroll takes it out before tax, and the employer deposits it into each employee's HSA.

A Section 125 cafeteria plan is a written plan under Internal Revenue Code Section 125 that lets employees choose between taxable cash pay and certain tax-free benefits. Summit Health Benefits' Section 125 cafeteria plan guide covers the basics. Code Section 125(d)(2)(D) carves HSA contributions out of the cafeteria plan ban on deferred compensation, which is what lets a cafeteria plan offer them.

A health savings account, or HSA, is a tax-exempt account an employee owns and keeps for life. To contribute, the employee must be covered by a high-deductible health plan, or HDHP, and have no other disqualifying coverage.

Is an HSA a Cafeteria Plan?

An HSA is not a cafeteria plan. An HSA is a personal savings account under Code Section 223, and a cafeteria plan is an employer payroll plan under Code Section 125 that can feed money into that account pre-tax.

People mix them up because both show up on the same benefits enrollment form. The difference matters for taxes:

What Is the Difference Between Section 125 and HSA?

Section 125 is the tax rule that makes payroll deductions pre-tax, while the HSA is the account where the money ends up. One is the pipe and the other is the bucket.

An employee who funds an HSA outside payroll can still claim an above-the-line deduction on Form 8889. That saves federal income tax but not FICA. Through a cafeteria plan, the same dollars skip federal income tax, the 6.2% Social Security tax and the 1.45% Medicare tax, and the employer skips its matching 7.65% too, per IRS Publication 15-B (2026).

The HSA money also shows up differently on the W-2. Pre-tax HSA dollars, including the employee's own salary reduction, are reported in Box 12 with code W, per IRS Publication 969 (2025). They are not added to Box 1 wages.

How Much Can an Employer Save by Running HSA Contributions Through Section 125?

An employer saves 7.65% of every HSA dollar employees elect through a Section 125 cafeteria plan, because those dollars are not FICA wages. A 10-person team electing $550 a month each in premiums and HSA money saves the employer about $5,049 a year in FICA.

FICA is the combined Social Security and Medicare payroll tax. The employer and the employee each pay 7.65% on wages up to the Social Security wage base, per IRS Publication 15 (2026). Summit Health Benefits' guide to maximizing FICA tax savings shows the math for other benefits.

Worked example: a 10-person HDHP team

Take a hypothetical 10-person company with an HSA-eligible HDHP. Each enrolled employee pays $300 a month toward the premium and elects $250 a month into an HSA, both through the cafeteria plan. Each employee is in the 12% federal bracket.

The HSA portion alone accounts for $19.13 of employer FICA savings per person each month ($250 x 7.65%). Without the cafeteria plan, that money would come out of payroll after FICA.

Summit Health Benefits charges $35 per enrolled employee per month, or PEPM, and that fee is paid out of the employer FICA savings the plan creates. In Summit Health Benefits' pricing model, typical employer FICA recapture runs $91 to $136 PEPM, so employers usually net about $56 to $101 PEPM after the fee. Your result depends on how much employees elect. At lower elections, like the example above, the bigger win is the employee take-home lift, which helps with hiring and retention.

What Are the HSA Contribution Limits for 2026 and 2027?

The HSA contribution limits are $4,400 for self-only and $8,750 for family coverage in 2026, and $4,500 and $9,000 in 2027, per IRS Revenue Procedure 2026-24. Employees 55 or older can add a $1,000 catch-up contribution each year.

The limit covers every dollar that goes in, from the employee and the employer combined. Pre-tax elections through the cafeteria plan count as employer contributions for this purpose, per IRS Publication 969 (2025).

Source: IRS Revenue Procedure 2026-24 (2026) and prior-year IRS guidance. Summit Health Benefits' full HSA contribution limits guide covers proration for people who join mid-year.

One state wrinkle: California does not follow the federal HSA exclusion, so California employees still owe state income tax on HSA contributions, per the California Franchise Tax Board. The federal and FICA savings still apply.

Can Employees Change HSA Contributions Mid-Year in a Cafeteria Plan?

Employees can change HSA contributions mid-year in a cafeteria plan. IRS Notice 2004-50, Q&A 58, lets an employee start, stop, increase or decrease an HSA election at any time, as long as the change applies going forward.

This is different from health premiums and health FSA elections, which are locked for the plan year except for events allowed under Treasury Regulation 1.125-4. The reason is that HSA eligibility and limits are set month by month under Code Section 223.

Employers may limit changes to once a month, but the plan must allow at least that, per the same Q&A. Write this into your plan document so payroll and HR follow the same rule.

Does an HSA Through a Cafeteria Plan Have to Pass Nondiscrimination Testing?

An HSA offered through a cafeteria plan must pass the Section 125 nondiscrimination tests, not the HSA comparability rules. Treasury Regulation 54.4980G-5 says this applies even when the employer adds matching or seed money through the plan.

That is good news for most small employers. The comparability rules force equal employer contributions across similar employees, with an excise tax of 35% of total employer HSA contributions for a miss, per Code Section 4980G. Running the money through Section 125 lets you match employee elections, as long as the plan does not favor highly compensated or key employees.

Summit Health Benefits' guide to Section 125 nondiscrimination testing explains the eligibility, contributions and key employee tests.

Section 125 HSA Compatibility: Which Plans and Benefits Work Together?

Section 125 HSA compatibility depends on the health plan and on the other benefits in the cafeteria plan. The employee needs an HSA-eligible HDHP and no general-purpose health FSA, or HSA eligibility is lost for that month.

Watch these combinations:

1. General-purpose health FSA. It disqualifies HSA contributions. Offer a limited-purpose FSA for dental and vision instead. Summit Health Benefits' HSA vs FSA guide compares them.
2. Bronze and catastrophic plans. These count as HSA-compatible starting January 1, 2026, per IRS Notice 2026-5.
3. Telehealth before the deductible. This is permanently allowed for plan years starting on or after January 1, 2025, per Notice 2026-5.
4. Direct primary care. A direct primary care arrangement no longer blocks HSA eligibility in 2026 if fees are $150 a month or less, or $300 for more than one person, per Notice 2026-5.

How Do You Set Up an HSA 125 Cafeteria Plan?

You set up an HSA 125 cafeteria plan by adopting a written Section 125 plan document that lists HSA contributions, then connecting payroll to an HSA custodian. The plan must be in place before the first pre-tax deduction.

1. Confirm the health plan is HSA-eligible. Check the deductible and out-of-pocket numbers against the 2026 IRS table above.
2. Adopt or amend the plan document. The document must name HSA contributions as a benefit and state the election change rule.
3. Pick an HSA custodian. A bank or trustee holds each employee's account.
4. Set up payroll codes. HSA deductions must be excluded from federal income tax and FICA wages and reported in W-2 Box 12, code W.
5. Run enrollment. Give each employee an election form and a way to change it monthly.
6. Deposit on time. Send each payroll's HSA money to the custodian promptly.

Summit Health Benefits' step-by-step guide on how to set up a Section 125 plan covers the plan document in more detail, and the cafeteria plan limits guide lists every 2026 pre-tax cap in one place.

Free copy-paste checklist for your payroll provider

Subject: Pre-tax HSA setup check

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Hi, please confirm for our company: (1) HSA deductions are excluded from federal income tax, Social Security and Medicare wages, (2) HSA amounts are reported in W-2 Box 12 with code W, (3) employees can change HSA elections at least monthly, (4) the HSA deduction code is tied to our Section 125 plan, and (5) the date each payroll's HSA money is sent to the custodian. Thank you.

Frequently Asked Questions

Sources

Internal Revenue Code Sections 106, 125(d)(2)(D), 223 and 4980G; IRS Revenue Procedure 2026-24 (May 2026); IRS Publication 15, Employer's Tax Guide (2026); IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits (2026); IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans (2025); IRS Notice 2004-50, Q&A 58 (2004); IRS Notice 2026-5, HSA guidance under the One, Big, Beautiful Bill (2026); Treasury Regulation 1.125-4; Treasury Regulation 54.4980G-5 (T.D. 9277, 2006); California Franchise Tax Board, Schedule CA (540) instructions (2025).