Understanding FSAs, HRAs, and HSAs

When it comes to offering health benefits, employers have several options to help employees manage healthcare expenses for themselves and their eligible dependents. Three common arrangements are Health Flexible Spending Accounts (FSAs), Health Reimbursement Accounts (HRAs), and Health Savings Accounts (HSAs). Each of these accounts has distinct features, benefits, and requirements. Here’s a breakdown of what each is, how they work, and the key similarities and differences among them.

What is a Flexible Spending Account (FSA)?

A Flexible Spending Account (FSA) is a tax-advantaged account that employees may use to pay for eligible medical expenses for themselves and their eligible dependents. Employees contribute to their FSA through pre-tax payroll deductions, which reduces their taxable income. The employer may also contribute to the FSA, though it’s not required. Expenses eligible for reimbursement must be “medical” as defined in the Internal Revenue Code and not for general good health.

Key Features of Health FSA:

1. Contribution Limits: The IRS sets annual limits on FSA contributions, which for 2024 is $3,050 per employee.
2. Use-It-or-Lose-It Rule: FSAs are typically subject to the “use-it-or-lose-it” rule, meaning that funds not used by the end of the plan year (or grace period, if offered) are forfeited. There is a limited exception if the plan includes a carryover feature which allows a certain amount of unused contributions to be carried over to be used in the next plan year.
3. Eligible Expenses: FSAs can be used for a variety of medical expenses, including copayments, prescription drugs, medical supplies, and other out-of-pocket healthcare costs. Reimbursements must be for medical expenses and not for items for general good health.

What is a Health Reimbursement Account (HRA)?

A Health Reimbursement Account (HRA) is an employer-funded account used to reimburse employees for qualified medical expenses for themselves (and if allowed by the plan document, their eligible dependents). Unlike FSAs and HSAs, only the employer contributes to an HRA. Employees may not contribute to an HRA account. Expenses eligible for reimbursement must be “medical” as defined in the Internal Revenue Code and not for general good health.

Key Features:

1. Employer Contributions: Employers have complete control over how much they contribute to each employee’s HRA.
2. Rollover: Depending on the plan design, unused HRA funds may roll over from year to year at the employer’s discretion.
3. Eligible Expenses: HRAs can cover a broad range of healthcare expenses, similar to FSAs, and may also include health insurance premiums, depending on the specific plan.

What is a Health Savings Account (HSA)?

A Health Savings Account (HSA) is a tax-advantaged account available to individuals enrolled in a High Deductible Health Plan (HDHP). Both employees and employers may contribute to an HSA, and the funds are used to pay for qualified medical expenses for the employee and their eligible dependents. Expenses eligible for reimbursement must be “medical” as defined in the Internal Revenue Code and not for general good health.

Key Features:

1. Contribution Limits: For 2024, the contribution limit for an individual with self-only coverage is $4,150, and for family coverage, it is $8,300. Individuals age 55 and older can contribute an additional $1,000 as a catch-up contribution.
2. Portability: HSAs are owned by the employee and are fully portable. This means the account stays with the employee even if they change jobs or retire.
3. Triple Tax Advantage: Contributions to an HSA are tax-deductible, the funds grow tax-free, and withdrawals for qualified medical expenses are also tax-free.

Comparing and Contrasting FSAs, HRAs, and HSAs

1. Funding Sources:
   • FSA: Funded by employee contributions, with optional employer contributions.
   • HRA: Funded solely by the employer.
   • HSA: May be funded by either the employee or employer or both, with the employee owning the account.
2. Ownership and Portability:
   • FSA and HRA: Owned and controlled by the employer. Funds do not follow the employee if they leave the company.
   • HSA: Owned by the employee. Funds are fully portable and remain with the employee regardless of employment status.
3. Contribution Limits and Rules:
   • FSA: Subject to annual contribution limits set by the IRS; funds are typically forfeited if not used by the end of the plan year.
   • HRA: No federal limit on contributions; rollover options are at the employer’s discretion.
   • HSA: Subject to higher contribution limits; funds roll over year to year, and there is no “use-it-or-lose-it” rule.
4. Eligibility Requirements:
   • FSA: Available to employees regardless of their health plan.
   • HRA: Available only to employees if offered by the employer; no specific health plan required.
   • HSA: Must be enrolled in a High Deductible Health Plan (HDHP) to be eligible and cannot have other plan-based coverage.
5. Tax Benefits:
   • FSA: Contributions are pre-tax, reducing taxable income.
   • HRA: Reimbursements are tax-free for employees.
   • HSA: Triple tax advantage—contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified expenses are tax-free.
6. Usage Flexibility:
   • FSA and HRA: Funds can generally be used for a wide range of qualified medical expenses.
   • HSA: Funds can be used for a broader range of expenses, including long-term care insurance and Medicare premiums after age 65.

Conclusion

FSAs, HRAs, and HSAs each offer unique advantages for managing healthcare costs. HR professionals should understand these differences.

Offering an appropriate healthcare account option for employees is an important decision for employers, as it directly impacts the overall well-being and satisfaction of the workforce. Employers must carefully evaluate the unique needs of their employees, considering factors such as demographics, healthcare usage patterns, and financial preferences. For instance, an HSA paired with a High Deductible Health Plan (HDHP) might be ideal for a younger, healthier workforce that values the ability to save for future expenses. On the other hand, an FSA could be more suitable for a workforce that anticipates regular, predictable healthcare expenses within a year. HRAs, that offer flexibility in plan design and funding, may be an attractive option for employers looking to provide comprehensive coverage without requiring employee contributions.

The decision to implement an FSA, HRA, or HSA should also take into account the administrative complexity, potential cost implications, and the long-term financial impact on both the employer and employees.

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