HSA vs. HRA vs. FSA

Before the Health Savings Account (HSA) was created, there were other similar kinds of health care funding options. They include the Health Reimbursement Arrangement (HRA) and the Flexible Spending Account (FSA).

While these types of accounts all have the same basic function — to help provide consumers with tax-advantaged funds for health and medical expenses — there are some big differences between them.

Health Savings Accounts (HSA)

The Health Savings Account (HSA) is the most flexible kind of account to help pay for medical expenses.

Quick facts about HSAs:

• Most people with qualifying coverage who are not eligible for Medicare are qualified to open an HSA
• Funds roll over year to year
• Savings can earn interest like any bank account
• Employers can make contributions and that money is completely owned by you, even if you change jobs
• Most health-related expenses can be paid for with HSA funds
• After age 65, funds can be withdrawn for any reason and taxed as normal income

Contributions to your HSA can be made through pre-tax payroll deductions or through tax-deductible contributions. Annual HSA contributions are limited depending on the type of HDHP coverage that is utilized by the HSA holder. For example, if a consumer has individual-only coverage, the yearly contribution limit for 2010 and 2011, is $3,050, but a covered family can contribute up to $6,150. More regulations are discussed in IRS Publication 969. An HSA is only compatible with a high deductible health plan.

The money you put into an HSA can earn interest and can be used for qualified medical expenses, which are detailed in IRS Publication 502. To qualify for an HSA, you must enroll in a high deductible health plan. Additionally, you cannot be claimed on someone else’s tax return as a dependent to open an HSA.

If you want to use HSA monies to pay for qualified medical expenses, funds can be withdrawn as needed on a tax-free basis in accordance to the IRS Publication 502 regulations. Any money withdrawn for non-qualifying expenses before the age of 65 will be subject to a tax penalty and income taxes. If money is withdrawn for non-qualified expenses after the age of 65, there is no tax penalty but income taxes will still need to be paid.

HSAs have a rollover function so any amount in the HSA that is not utilized by the end of the year continues to be available into the next year. Additionally, the account is individually owned so the funds cannot be taken away for any reason, even if you switch employers.

Health Reimbursement Arrangements (HRAs)

While HSAs are owned by the individual, HRAs are owned by the employer, and only the employer can make contributions to the account. The account does not pay interest and may rollover depending on the plan design. Employees cannot usually take unused HRA dollars with them when they change jobs or retire. Expenses must meet the requirements of the specific HRA plan design to qualify for reimbursement.

Quick facts about HRAs:

• HRAs are not portable from job to job
• Funds are owned by the employer
• Only plan-qualified expenses are eligible for reimbursement
• Unused funds may not rollover from year to year

Flexible Spending Accounts (FSA)

A Flexible Spending Account (FSA) is an account a person’s employer sets up in conjunction with a medical plan offered by that employer. A portion of payroll money is deducted before taxes and the employee decides how much to contribute, either in a percentage or set dollar amount, at the beginning of the year.

Quick facts about FSAs:

• Leftover funds are forfeited at the end of the year
• FSAs will be capped at $2,500 starting in 2013
• Employer must offer this benefit to qualify
• FSAs are not portable from job to job
• A claim is normally required to receive reimbursement
• Funds can be taken directly from paycheck

While there is currently no limit on the amount that can be contributed to an FSA, the funds do not roll over so that if the money in the FSA is not used by the end of the plan year, they are redistributed according to the plan document. The money set aside in the FSA is used to reimburse qualified medical expenses claimed by the FSA participant; however, unlike other plans, these funds cannot be used for non-qualified medical expenses.

Contributions made to an FSA will be forfeited if the individual decides to switch jobs. Both employer and employee can make FSA contributions, but only employer-made contributions are tax deductible. These funds are not considered as imputed income, or a benefit of employment above the amount of wages paid.

Eligible participants in a company’s FSA include any current employees. Sole proprietors, owners or partners of an “S” Corporation are not eligible to participate in an FSA.

Qualified Medical Expenses for HSAs and FSAs

Here are some qualifying medical expenses for HSAs and FSAs according to the IRS Tax Code Section 201 and Publications 502 and 969:

• HSA qualifying medical expenses include the deductible of the high deductible health plan, copayments, catastrophic illness and emergency treatment and many prescription drugs in addition to preventive care.
• Non-eligible medical expenses can be paid for with the HSA; however, tax penalties are associated with withdrawals and non-eligible expenses are counted as income. Some non-eligible expenses include advance payment for treatments, gym memberships and disabled person transportation, among other items.
• With an FSA, the same medical expenses (subject to plan design) are eligible for tax-free reimbursement, but non-qualifying expenses cannot be reimbursed at all, meaning under an FSA, an individual cannot make withdrawals for non-eligible expenses. This is essentially regulated by the reimbursements, since typically all eligible and medically necessary expenses must be paid for by the employee and then reimbursed if the employee shows the expenses were eligible.

Funding health care with the various accounts requires much forethought to be sure all of your necessary and unforeseeable future expenses are covered. There are advantages to each kind of account, but an HSA provides consumers more advantages concerning flexibility and portability.