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:
prohibition against rolling over more than $500 year to year
requirement that the maximum amount of reimbursement must be available at all times during coverage, and
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).