The ABCs of FSAs, HRAs, and HSAs/ June 7th, 2018
Selecting the right health plan can be confusing. So many choices make it difficult to determine which plan is right for you. The same can be said for the tax-advantaged savings plans used to save and pay for medical expenses. Flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), and health savings accounts (HSAs) all have unique features and benefits, and can help you save and pay for medical expenses—such as deductibles, coinsurance, and prescription drugs—but how do you determine which option is best for you? Start by understanding the differences between them.
Flexible Spending Arrangement
An FSA is a tax-advantaged account that can be used to pay for eligible medical expenses for you, your spouse, and your dependents. Eligible medical expenses are determined by IRS rules and your employer’s plan, but generally include amounts that you pay out of pocket for deductibles, copayments, prescription drugs, and dental and vision care. An FSA can be used with any type of health plan, although health insurance coverage is not required.
An FSA is established through your employer and funded by you with pre-tax contributions. If you elect to participate in an FSA, you may contribute up to $2,650 for 2018.
Because any remaining money in your FSA at year-end will be forfeited, it’s important to carefully estimate the amount of medical expenses you expect to incur during the year before deciding how much to contribute to your FSA. Your employer’s plan may offer a grace period to use the funds after year-end or may allow you to carry over up to $500 to the following year, but that is not a requirement. In addition, FSAs are not portable, so you cannot keep your FSA if you leave your employer.
Health Reimbursement Arrangement
An HRA is a tax-advantaged account that can be used to pay for eligible out-of-pocket medical expenses for you and your dependents. Eligible medical expenses are determined by your employer’s plan and can vary from company to company, so you will need to check your employer’s plan to determine eligible expenses.
An HRA is integrated with your employer’s group health insurance plan, established and administered by your employer, and funded exclusively with employer contributions. Your employer determines the amount contributed to the account each year. Employee contributions are not allowed.
As with an FSA, an HRA comes with the “use-it-or-lose-it” rule. Any unused portion of your HRA at the end of the year cannot be paid to you in cash. Your employer’s plan may allow unused amounts to be rolled over to subsequent years, but is not a requirement to offer this option. Also, HRAs are not portable. Any funds in the HRA remain with the employer if you switch employment.
Health Savings Account
An HSA is a tax-advantaged account that can be used to pay the qualified medical expenses of the HSA owner, the HSA owner’s spouse, and dependents. All contributions to the HSA are tax- deductible, the earnings on the account are tax-deferred, and distributions are tax-free if used to pay for qualified medical expenses.
To contribute to an HSA, you must be covered under an HSA-compatible high deductible health plan (HDHP), not be covered by any other non-HDHP or enrolled in Medicare, and not be eligible to be claimed as a dependent on another person’s tax return.
For 2018, the HSA contribution limit is $3,450 for self-only coverage ($3,500 for 2019) and $6,900 for family coverage ($7,000 for 2019). If you are age 55 or older, you may make additional HSA catch-up contributions of up to $1,000.
You can use the money in your HSA to pay for deductibles, copayments for medical care and prescription drugs, coinsurance, and bills not covered by insurance, including vision and dental care expenses.
All withdrawals used to pay for qualified medical expenses are tax-free. Any amounts withdrawn and not used for qualified medical expenses are taxable and subject to an additional 20 percent penalty tax (unless the withdrawal was made after the HSA owner died, became disabled, or reached age 65).
An HSA has many advantages over an FSA and HRA. The “use-it-or-lose-it rule” does not apply and there is no time limit for withdrawing the assets. Also, the account is completely portable. HSA owners can take the account with them if changing employers or move their HSA assets to another financial organization, even if employer contributions were made.
But the real advantage of an HSA is the tax benefits. “FSAs, HRAs, and HSAs all allow you to pay for out-of-pocket medical expenses, but only HSAs provide a triple tax advantage. All HSA contributions are tax-deductible, the earnings are tax-deferred, and all distributions are tax-free if used to pay for qualified medical expenses,” according to Dennis Zuehlke, Compliance Manager for Ascensus, which provides HSA administration services to financial organizations nationwide. “There is no other tax-advantaged account that offers the same tax benefits of an HSA,” Zuehlke added.