Health savings accounts (HSAs), flexible spending accounts (FSAs) and health reimbursement accounts (aka, arrangements – HRAs) are all accounts used to pay for health care expenses.

The common thread between each of these accounts is that they all provide employees a means to control a portion of their health care dollars — but only HSAs can be opened by individuals outside of an employment arrangement.

Employers are often comparing the differences between these plans in an effort to choose the best one or to offer a combination of the accounts to maximize benefits for employees.

Substantial differences exist between the three plans, including how they are established, managed, funded, maintained, tax consequences, etc. 

Before comparing the plans, let’s review the peculiarities of each plan:

1. What are health savings accounts?

An HSA requires coverage under a high deductible health plan — FSAs and HRAs do not.

Unlike an FSA or HRA, an HSA is an individual custodial account that is owned by the individual rather than the employer.

The legal ownership is significant because it allows employees to use that money as they see fit: spending it on eligible health care expenses, saving it for the future, or even spending it on consumer goods (although penalties apply).

The fact that the account belongs to the employee also removes many of the compliance and administration requirements from the employer. For example, with HSAs, the employer is not required to review receipts. During 2016, HSAs allow for contributions as large as $3,350 for self-only and $6,750 for family plus a $1,000 catch-up for individuals over age fifty-five.

It is uncertain whether HSAs are subject to the “group health plan” rules under the Affordable Care Act.  IRS Notices 2013-54 and 2015-17 on the topic of group health plans did not address HSAs.

Presumably, HSAs are not group health plans for this purpose and an employer can continue to make HSA contributions for employees without integration with a health plan.

This issue is important because “group health plans” must meet certain “market reforms” under the Affordable Care Act.

One of the market reforms is that the plan cannot impose an annual limit on “Essential Health Benefits.” An HSA program would not meet this requirement and failure to meet the market reforms for a group health plan result in large daily penalties.

HSAs are not subject to the following rules that Flexible Spending Accounts (FSAs) (see below) must meet including the:

  1. prohibition against rolling over more than $500 year to year

  2. requirement that the maximum amount of reimbursement must be available at all times during coverage, and

  3.  mandatory twelve-month period of coverage

It should be noted that HSAs have some obvious features that are common with retirement accounts including rollovers, portability, choice of investment types and risks, as well as survivor benefits. In addition to those similarities, there are also advantages including:

  • Exempt from paying FICA tax on contributions made from payroll

  • Greater liquidity options–ability to keep funds in insured accounts if one desires as well as being able to move money for investments with greater return

  • Can contribute both earned and unearned income

  • Funds can be used at any time/any age for qualified medical expenses

  • Can continue to contribute to account after end of employment

2. What are flexible spending accounts?

An FSA is an account established as part of a Section 125 Cafeteria plan that allows employees to defer a portion of their income to pay for medical expenses on a tax-free basis.

FSAs are a popular employee benefit in large part because of the tax benefits and FSAs work with a traditional health plan.

In the case of the FSA, the employer owns the account and is responsible for its management; including paying claims as they occur (often this is accomplished by hiring an outside administrator).

Money left over at the end of the year reverts back to the employer and not the employee.

However, IRS Notice 2013-71 allows employers to amend their Section 125 Cafeteria plans in order to allow the FSAs to offer a rollover of up to $500 per year.

Employers are not required to allow for the rollover and could limit the amount to less than $500. Employers are not, however, allowed to increase the amount of the rollover above the $500 threshold.

As part of the Affordable Care Act, FSA contributions are now limited to $2,550. General health FSAs are considered “other health coverage” and disqualifies a person for an HSA. However, employers may offer limited-purpose FSAs and combine that offering with an HSA offering.

If an employee does roll over some or all of the allowed $500, the amount rolled does not count against the employee’s next year FSA contribution limit.

Accordingly, an employee rolling over the maximum $500 could still elect to defer $2,550 for the next year (or an amount as adjusted for inflation). The IRS states that “this carryover option provides an alternative to the current grace period rule and administrative relief similar to that rule” so an employer cannot offer both a rollover and a grace period (some transitional relief applies).

An FSA can avoid some of the rules applicable to group health plans if classified as “excepted benefits”.  A health FSA will be classified as “excepted benefits” if:

  • other (nonexcepted benefit) group health plan coverage is made available to employees by the employer; and

  • the arrangement is structured so that the maximum benefit payable to any participant cannot exceed two times the participant’s salary reduction election for the arrangement for the year (or, if greater cannot exceed $500 plus the amount of the participant’s salary reduction election).

3. What are health reimbursement accounts?

Also called Health Reimbursement Arrangements, an HRA is an employer-provided and employer-funded account that allows employees to direct a portion of their health care spending.

The employer contributes funds to the employees HRA account and the employee can spend the funds on eligible health care expenses. The HRA dollars must be linked to a health insurance plan.

HRAs work very similar to an FSA — however, the rules are more flexible and allow for a variety of different designs. For instance, an HRA may allow employee funds to rollover year-after-year and grow for future use.

With an HRA, the employer is also responsible for compliance and administration (often accomplished through the hiring of an outside administrator).

HRAs are becoming popular with employers that offer HDHPs to their employees, as HRA funds can offset the first dollar out of pocket for the employee.  The employer actually pays only after the employee incurs expenses.

Unlike an HSA, there are no annual limits to the amount of money the employer can contribute to the account.  The HRA may reimburse any expense considered to be a qualified medical expense under Section 213 of the Internal Revenue Code, including premiums for personal health insurance policies.

Within IRS guidelines, employers may restrict the list of reimbursable expenses in any way they choose for their HRA plan.

Health reimbursement arrangement balances may roll forward from year to year. Employers can design the program not to allow balances to roll over from one year to the next.

However, limiting the rollover feature defeats a key Health Reimbursement Arrangement advantage. Employers may allow employees to have access to their Health Reimbursement Arrangement accounts after retirement.

However, employers may not pay/distribute cash or other benefits balances to any employee on the HRA plan.

4. What advantages are there when choosing an HSA, FSA, or HRA?

Although there is no simple answer as to which of these vehicles to choose or whether one is the best for someone, some advantages of each are outlined below:

Advantages of HSAs: 

  • Minimal Administration: An HSA generally works well for employers that want to minimize administration and compliance issues.

  • Flexibility and Portability: Employers desiring to offer the most flexible solution for employees are often drawn to the HSA as it allows for portability, the opportunity for investment growth (HRAs may offer this as well), and the distribution of funds for nonmedical reasons (including for any purpose at age sixty-five without penalty).

  • Minimal Cost and Involvement: Employers often offer HSAs because the employer does not have to fund any portion of the account.

  • Owned by Employee: Employees may prefer HSAs to FSAs because the funds belong to them, therefore they do not need to worry about being as precise in estimating their medical expenses. Further, they benefit personally from lowering their healthcare expenses, unlike FSAs where an employee may end up rushing to spend money on health care at the end of the year in order to avoid losing funds.

Advantages of FSAs: 

  • Works Well with traditional health care plans: Employers offering traditional health care plans often prefer FSAs, primarily because HSAs are not an option with traditional insurance since an HDHP is required to be eligible).

  • Greater Flexibilities: A traditional health plan limits the deductible so that the rollover feature of HSAs is less important and it’s also easier for an employee to estimate expenses. FSAs allow employees to defer extra income into the FSA to pay for co-pays, medical bills not covered by insurance, as well as dental and vision care.

  • Employer Gets to Keep Unspent Funds: One significant benefit of FSAs over HSAs, from the employer’s perspective, is that the employer gets to keep unspent money at the end of the year (except up to $500 rollover amount if employer allows for rollovers).

Advantages of HRAs: 

  • Flexibility in Plan Design: HRAs allow the most flexibility in plan design and are favored by more sophisticated employers (generally larger employers that have complex benefit packages).

  • Ability to offer with other plans: The inability to allow for payroll deferral reduces the attractiveness of HRAs as the only offering, but HRAs can be offered in connection with a health FSA and to a limited extent an HSA.

  • Self-Insured Employers: HRAs also work well for employers that self-insure. The HRA provides a method for self-insuring employers to put in consumer-directed efforts to reduce overall health care costs and increase employee satisfaction at the same time.

  • Complicated Administration: HRAs are more complicated to administer than HSAs.

  • Employer Funded: A key limitation of HRAs is that only the employer can fund the HRA.

5. Can an employer offer both an FSA and HSA?

Yes, but either not to the same employee or the FSA must be a limited-purpose FSA.

An employee covered under an HDHP and another first-dollar insurance plan is not eligible for an HSA. An FSA that reimburses for qualified medical expenses is considered to be another insurance plan and would make the covered person ineligible for an HSA.

One approach is for an employer to offer an FSA for employees that elect a traditional health plan and an HSA for those that elect an HDHP.

Another option is for the employer to offer a limited-purpose FSA that only covers dental and vision expenses and is allowed along with an HSA (a post-deductible FSA or HRA are additional options).

6. Can an employer offer both an HRA and an HSA?

An employer can offer both an HRA and an HSA.

However, they cannot offer both to the same employee or the HRA must be a limited-purpose HRA or a post-deductible HRA. An employee covered under an HDHP and another first-dollar insurance plan is not eligible for an HSA.

An HRA that reimburses for qualified medical expenses is considered another insurance plan and would make the covered person ineligible for an HSA.

A limited-purpose HRA that only covers dental, vision and preventive care does not make a person ineligible for an HSA. The HRA can also pay or reimburse premiums for coverage by an accident or health plan.

7. Can an employer offer all three — an HRA, FSA, and HSA?

An employer can offer an HRA, FSA, and HSA but will have to be careful if they want their employees to remain HSA-eligible.

The employer could offer HDHP coverage, a limited-purpose FSA, and a post-deductible HRA, and its employees would still be otherwise eligible for HSAs.

8. What are the tax consequences for HSAs, HRAs, and FSAs?

Basically all three types of plans enjoy tax-free treatment for health care expenses. The rules of deductibility can be different, however.

  • HSA contributions are deductible by the employer when made by the employer as a “comparable” contribution or when made by employee payroll deferral through a Section 125 plan. In both cases the contribution will not show as income on the employee’s income tax return. Individuals may also contribute directly to an HSA and deduct the amount on their income tax return.

  • FSA contributions are deductible by the employer and not income to the employee. The contribution is not subject to FICA/FUTA.

  • HRA contributions are deductible by the employer and not income to the employee. The contribution is an employee benefit not subject to FICA/FUTA.

9. How can I compare HSAs, FSAs, and HRAs?

The following chart can be helpful in discerning the differences between the plans:

 

See also:

Is the stand-alone HRA making a comeback?

On the Third Hand: HRAs

3 new IRS health account rules

 

You’re invited to join us on Facebook.