Among the major options for managing benefit costs include flexible spending accounts (FSAs), health savings accounts (HSAs), and health reimbursement arrangements (HRAs). When it comes to an HSA, FSA, and HRA, what are the best options for your business?
Understanding your health spending account options
Although there may be similarities between them, HSAs, FSAs, and HRAs are different from one another, and each one has distinct benefits for you and your employees. Understanding the differences can save you valuable time and money by helping you determine which type of health benefit account is the best solution for your HR needs.
Health savings accounts (HSAs)
What is a health savings account?
HSAs are an elective benefit that an employer can offer as a way for employees to set aside tax-advantaged medical savings to pay for copays, deductibles, and other qualified medical expenses. But there's a catch: Only individuals who are covered by a high-deductible health plan (HDHP), as determined by the IRS, and are not enrolled in Medicare are eligible for an HSA. Contributions are made into the account by the employee and/or the employer up to a maximum amount each year. For 2019, that amount is $3,500 for individual coverage and $7,000 for family coverage. An HSA works much like a standard checking account (often including a debit card), and it's up to the employee to track their contributions, expenses and reimbursements.
Who is an HSA for?
HSAs are a more suitable option for healthier employees who go in for predictable, annual checkups and have infrequent medical needs. Employees with Medicare are not eligible for an HSA; however, HSA funds that have accrued when an employee was eligible can be used to pay Medicare premiums when the employee turns 65.
"This is a great plan for your healthy workforce with low medical costs and your wage earners who are going to want to hold on to that money they set aside, tax-free," says Shannon Anderson, senior HR generalist at Paychex.
Whatever employees save in HSAs they can keep, grow tax-free, and then withdraw from, even years later. Those withdrawals are still tax-free as long as the money is spent on qualified medical expenses.
Who owns the account?
HSAs are owned by the individual employee and follow the individual even if that person resigns, retires, or is terminated. This feature is one of the biggest differences between an HSA and HRA, which is owned by the employer.
What expenses are covered by a health savings account?
Qualified medical expenses include most medical care such as dental, vision, and IRS eligible over-the-counter drugs. A few examples of expenses are:
- Office visit copays
- Health insurance deductibles
- Dental expenses (tooth extraction, fillings, etc.)
- Vision care (eye exams and eyeglasses)
- Prescription drugs and insulin
- Medicare premiums
- A portion of the premiums for a tax-qualified, long-term care insurance policy
- Hearing aids
- Imaging (X-rays, MRIs)
- Wheelchairs, walkers, and crutches
IRS Publication 502 provides a comprehensive list of covered medical and dental expenses.
How to use an HSA to your advantage
A high-deductible health plan with an HSA can save a business money because a qualified HDHP is required for employees to contribute to their HSA and, generally, HDHP premiums are lower than traditional plans.
"Recent studies have shown that employers who are on a high-deductible (consumer-driven) health plan are more cost-conscious of what they are spending, therefore giving savings to themselves and their employer," Anderson says.
There are employer tax benefits as well. Reducing an employee's taxable income decreases your tax liability. The lower an employee's Federal Insurance Contributions Act (FICA) tax liability, the less you're required to pay.
Flexible spending accounts (FSAs)
What is a flexible spending account?
An FSA is an employer-established plan that pays for qualified medical and dependent care expenses (with a dependent care FSA) with pretax dollars, prior to federal withholding, FICA tax, or state withholding taxes (in most states) being applied to the amount deducted from the employee's pay. Employers and employees may both contribute to the FSA. Having an HDHP is not a prerequisite for having an FSA. Employees must submit a claim to get reimbursed from their FSA.
Who is an FSA for?
An FSA is a good choice for employees who expect to have frequent high medical care costs, such as those associated with a chronic illness. Because an FSA can be paired with a low-deductible health plan, an employee can potentially meet the deductible faster. Additionally, employees have immediate access to the full amount they plan to contribute for the tax year, making it a good option for those who have medical expenses earlier in the year. FSAs cannot be used to pay Medicare premiums.
Who owns the account?
The employer owns the FSA. Once an employee leaves the company, that account is closed and, unlike the HSA, the account does not follow the individual. As the account owner, you have three options for choosing what to do with unused funds. These are:
- Forfeiture. At the end of the year, unused FSA funds are forfeited and the employer keeps it.
- Carryover. Employees can carry over up to $500 (you determine the limit up to this amount) of unspent FSA funds to next year's plan. Unspent FSA funds over this limit are forfeited to the employer.
- Grace period. You can offer a 2.5-month grace period after the plan year ends to claim reimbursement of FSA funds. Remaining money stays with the employer.
What expenses are covered by a flexible spending account?
Except for Medicare premiums, an FSA covers many of the same qualified medical and dental expenses that are covered by an HSA. For a complete list of what is and isn’t covered, review IRS Publication 502.
How to use an FSA to your advantage
Like the HSA, employer/payroll deposits and claim payments are tax-free. Pretax contributions from the employee reduce the employee's taxable income and tax liability. Employers are not required to pay the employer portion of the Social Security tax on the contributions employees makes to their FSAs. Employees may be able to contribute to both an HSA and FSA at the same time, but special conditions and restrictions often apply.
Health reimbursement arrangements (HRAs)
What is a health reimbursement arrangement?
A health reimbursement arrangement is an employer-funded plan that supplements health insurance benefits and pays for a range of medical expenses not covered by insurance. HRAs are among the most flexible types of employee benefits plans. Unlike an HSA, employees cannot contribute to an HRA.
Who is an HRA for?
An HRA is advantageous for all employees. HRAs will reimburse Medicare premiums, and employees can use these funds to cover medical expenses for spouses and dependents. It's the most flexible of all the medical savings accounts and doesn't require an HDHP.
There's also an HRA option that's for businesses under 50 employees. This is the qualified small employer health reimbursement arrangement (QSEHRA), and can be used to reimburse employees for qualified medical expenses. The cost of their premiums is tax-free when the employer isn't providing medical insurance.
Who owns the account?
HRAs are owned and funded entirely by the employer. This attribute is the biggest difference between HRA and HSA benefits. There are no limits to how much an employer can contribute. Employers can roll over unused funds into the next year or set a maximum rollover limit.
What expenses are covered by an HRA?
HRAs cover qualified medical expenses, as defined by the IRS, which states that medical expenses are "the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes."
There are 65 IRS-approved medical expenses, and businesses have the freedom to specify which expenses are excluded from their plans.
How to use an HRA to your advantage
For starters, contributions to an HRA are 100 percent tax-deductible. Because the plans are fully funded by the employer, the company can make a knowledgeable estimate on its maximum expense for health benefits for that year. Additionally, reimbursements are tax-free up to the maximum amount for that coverage year. Finally, HRAs are a "use it or lose it" account, where any balance expires at the end of each plan year. Employers can choose to carry over a set amount of unused funds into the next year. This feature results in employers typically incurring a financial responsibility that's less than the total value of an employee's HRA.
Which health spending account is right for you?
HSA, FSA, or HRA — determining which plan or combination of plans is optimal for your business can be confusing, even after carefully studying the differences. Variations such as rollover options, employer contributions, funding limits, funding schedules, and reimbursement options affect how you maximize value for you and your employees. Not-so-obvious conditions like retention issues, employee satisfaction, and whether you're under extreme short-term financial pressures are also worth considering.
You can get help with this important decision. It's prudent to spend time talking with an experienced health benefits specialist who's familiar with the intricacies of each type of health benefits account and can help you find the best option for your organization. After all, a healthy, thriving workforce can be one of your greatest assets.