Maryland Life and Health Insurance License Practice Exam

What happens to an employee's payroll contribution to a Health Savings Account (HSA) if there is no Section 125 Plan in place?

1. It is considered taxable income

2. It is deducted pre-tax from payroll

3. It rolls over to the next year tax-free

4. It can still be contributed by the employer

The correct answer is: It is considered taxable income

When an employee's payroll contribution to a Health Savings Account (HSA) is made without the benefit of a Section 125 Plan, the contributions are considered taxable income. A Section 125 Plan, also known as a cafeteria plan, allows employees to make pre-tax contributions to certain benefits, including HSAs. Without such a plan, contributions made directly from an employee's paycheck are not deducted from income before taxes are calculated, which means the employee must pay income tax on those contributions. This distinction is crucial for understanding the tax implications of HSA contributions and the benefits of utilizing a Section 125 Plan for tax savings. In contrast, when a Section 125 Plan is utilized, contributions can be made pre-tax, which reduces the employee's taxable income. The option for rollover to the next year tax-free and employer contributions are also dependent on proper plan structures and regulations. However, in the absence of a Section 125 Plan, the fundamental aspect that contributions are taxed as income is what is highlighted in the correct answer.