Health Reimbursement Accounts (HRA) and Health Savings Accounts (HSA) are two types of accounts for the payment of out-of-pocket medical expenses that are IRS sanctioned and tax advantaged. Both plans are useful ways to offset health care costs in a manner the can be greatly beneficial for employees. The key difference between the two is that one is employer funded (HRA) and one is employee funded (HSA), but there are some additional differences to consider. Many employers offer both options to employees so it is important to understand the differences when making your decision on choosing a HRA or a HSA.
Health Reimbursement Accounts
HRA's are employer funded accounts set up to reimburse employees for medical expenses and health insurance premiums while providing a tax advantage for employees and employers. Key aspects of HRA's include:
- Employers don't actually have to fund the account until reimbursements are paid. This works well for employers as the account balance is essentially a notional one that while it accrues doesn't actually create a drain on cash flows until actual expenses are incurred.
- The contributions cannot be generated through any form of employee deductions, the account has to be purely funded by the employer.
- Unused funds can be rolled into future years for reimbursement.
- For employees reimbursements are tax free for qualified medical expenses and don't factor in any way into the employee's employment income.
- Broad applicability as both current and former employees are eligible as well as their spouse and dependents. Spouses and dependents of deceased individuals can also still access the accumulated funds
- IRS guidance on HRA arrangements is considered fairly opaque and complex for companies to understand. Reporting plans are also subject to Medicare mandatory reporting requirements, which can be incredibly difficult for some employers to understand and adhere to.
Employers like HRA's because they are tax deductible and it is easy to know what their maximum expense will be (as it is capped by the terms of the plan). Employees like HRA's because they are beneficial from a tax perspective also and have a great deal of flexibility to meet their family's health needs. It's important to note that self-employed individuals are ineligible and that highly compensated participants may be subject to limitations (a very vague statement that contributes to the opaqueness of IRS guidance on HRA's). There is also some concern that HRA's are not offered with a High Deductible Health Plan (HDHP) and may have restrictions starting in 2014 as a result of the Health Care Reform Law, though the full implications are still unknown.
Health Savings Accounts
HSA's are employee funded accounts to reimburse medical expenses and are only available to those who are enrolled in an HDHP and do not receive any other non-HDHP coverage (i.e. Medicare or a spouse's plan). Key aspects of HSA's include:
- Contributions can be made by an individual, an employer, or any other individual and are not taxable in any capacity.
- Contribution limits exist, with different limits for individual and family accounts. Older members (55 to 65) can contribute up to $1,000 more than the limits as a 'catch-up' contribution.
- Unused funds can be rolled over to later years.
- Funds can be withdrawn to pay for qualified medical expenses (as deemed by the IRS) and to pay health insurance premiums.
- Funds can be withdrawn for non-health care related expenses but are then included in income and a 20% penalty is applied if the individual is under 65.
Employees often like HSA's due to the increased flexibility and the ability to withdraw funds for non-health expenses if a significant balance accrues (even if a penalty is involved). As the employees own the actual account they can see significant growth through investment if they don't spend much from the account each year. In a way this provides one more tax shielded investment platform for retirement, with the added benefit that medical expense withdrawals will be tax free.
Which Option is Best for You?
Generally employers will prefer to use HRA's over HSA's when it comes to offering programs to employees. The have more control over expenses, can adjust the terms at their discretion, and potentially can end up not paying out accrued amounts if the funds are never claimed. Employees generally prefer HSA's, so when you have the option it is likely the better alternative. This is because HSA's are managed by you and you have more discretion in terms of how you spend your money. Additionally, the tax shielded investment aspect, if say you never actually withdraw significant amounts from the account, can be very useful for retirement planning.