Health Savings Accounts (HSA)
HSAs are tax-exempt trusts or custodial accounts — essentially savings accounts — established to cover qualifying medical expenses. If you qualify as an eligible individual, you can establish your HSA with an IRS-approved trustee, such as a bank or insurance company, or your employer can establish the HSA on your behalf. Your HSA may receive contributions from you or any other person, including your employer or a family member.
HSAs are used in conjunction with high deductible health plans, or HDHPs, which typically offer much lower premiums than more traditional health plans. The trade-off is that an HDHP’s annual deductible is much higher, thus the name. The HSA covers you up to the point at which the HDHP coverage kicks in.
The HSA offers a number of tax benefits. Contributions that you make are tax deductible without having to itemize. Contributions from your employer are not considered income. Amounts in the account grow tax-free and distributions for qualifying health care expenses are not taxed. And if you have a balance in the account at the end of the year, you can carry it forward to the next year.
Flexible Savings Accounts (FSA)
FSAs are established by employers to reimburse their employees for medical expenses, often as part of a cafeteria plan.
If you participate in an FSA, you’ll typically contribute pretax dollars throughout the year via a salary reduction arrangement with your employer, based on an amount determined at the beginning of the year. Your employer can also contribute to the FSA and generally those contributions are not includible in your income. Reimbursements from an FSA that are used to pay qualified medical expenses are not taxed.
FSAs are somewhat unique in that you can have a negative balance at times during the year. In other words, you can withdraw funds for qualified medical expenses before you have contributed the funds, as long as the total withdrawals do not exceed the total contributions you committed to make for the entire year.
The Affordable Care Act now caps annual contributions to an FSA at $2,500. Any balance remaining at the end of the year is generally forfeited.
Health Reimbursement Arrangements (HRA)
HRA plans are employer-funded medical reimbursement plans. The employer sets aside a specific amount of pre-tax dollars for employees to pay for health care expenses on an annual basis. Based on the plan design, HRAs can generate significant savings in overall health benefits.
The primary requirements for an HRA are that (1) the plan must be funded solely by the employer and cannot be funded by salary reduction, and (2) the plan may provide benefits for substantiated medical expenses only.
HRAs may be designed in many fashions to suit the specific needs of employer and employees alike. It is one of the most flexible types of employee benefits plans, making it very attractive to most employers.
Benefits to the Employer
HRAs are most commonly offered in conjunction with a High Deductible Health Plan. As a rule, moving to a HDHP will result in reduced premium costs, which creates real savings on healthcare costs for the employer. HRA contributions may then be funded using the savings gained from the lower premium costs. By funding an HRA, the employer effectively bridges the gap between the higher deductible and the expenditure amount at which the insurance coverage “kicks in” for their employees.
Most importantly, all employer contributions to the plan are 100% tax deductible to the employer, and tax-free to the employee.
Employers may establish what expenses the HRA funds may be used for; from as comprehensive as all health-related eligible expenses to as limited as emergency room expenses only. Because they are very flexible, HRA plans enable employers to control costs of providing healthcare benefits while providing a valuable employee benefit.