Out-of-pocket health care costs can become a burden for employees. Special accounts designed to cover health care costs can help both workers and employers manage their expenses. When considering the three main types of health accounts (HRAs, HSAs and FSAs), it’s important to understand their pros and cons before deciding what to offer your employees.
What are health accounts?
Health accounts or arrangements are designed to cover the costs of eligible health care services, typically including medical, vision and dental expenses. These setups can often provide substantial tax benefits as well.
While employers are not required to offer HSAs, FSAs or HRAs, many choose to do so. Health accounts can provide advantages to both the employer and the employee, including the following:
- Flexibility: It’s hard to find employee benefits that fit everyone’s needs. HSAs, FSAs and HRAs can give workers the flexibility to determine exactly how they want to spend their funds, so long as they follow the rules of the account.
- Reducing Stress: According to PwC, 60 percent of full-time employees are stressed about finances, including 47 percent of workers earning at least $100,000 a year. Unexpected medical costs are a major source of financial stress for many people, especially for emerging talent on your team. By offering an account dedicated to medical costs, you can help alleviate stress, improving your team’s focus and engagement.
- Taxes: Withdrawals are not typically subject to income tax, and contributions may be tax-free as well. This can reduce the income taxes that employees owe. Note that rules vary by account type, so check with the IRS for details on your organization’s specific health account.
- Attracting Talent: A robust benefits package can help set your company apart from other employers. FSAs, HSAs and HRAs can be very appealing to workers and boost your organization’s recruitment and retention efforts.
HRA vs HSA vs FSA: What’s the difference?
Although HRAs, HSAs and FSAs seem similar at first glance, there are important differences with significant implications for both employers and employees. Who owns them, who funds them and whether the unused funds expire are among the most critical differences.
Health Savings Account
A Health Savings Account (HSA) is a type of employee-owned account that is designed to work with high-deductible health insurance plans. HSA contributions, earned interest and withdrawals for qualified medical expenses are not taxed. However, if the money is used for anything other than qualified medical expenses, there is a 20 percent tax penalty in addition to federal income taxes. Once a person turns 65, the 20 percent tax penalty no longer applies, but withdrawals used for purposes other than qualified medical costs will still be subject to income tax.
HSAs are owned by the employee, not the employer, so they are fully portable when the employee changes jobs or retires. Furthermore, HSA funds never expire, so people who have HSAs and don’t need the funds can continue to grow their savings year after year, and the funds can earn interest.
Combined with the potential tax advantages, this means that HSAs are often used in retirement savings strategies. Someone who is young and healthy can contribute to an HSA knowing that, if they need the funds, they’ll have them, but if they don’t need them, they can use the money during retirement.
Cons to an HSA
Individuals who are not enrolled in high-deductible health plans cannot open or contribute to HSAs. If someone who owns an HSA enrolls in another type of health plan, that person retains the account but is no longer eligible to make contributions.
HSA contributions are subject to annual caps. For 2024, the contribution limit for self-only coverage is $4,150 and the contribution limit for family coverage is $8,300. There is also a $1,000 catchup contribution allowance for individuals aged 55 or older.
Flexible Spending Account
Flexible Spending Accounts (FSAs) are employer-owned accounts designed to cover qualified health care costs. FSAs are often funded by employees through payroll deductions, though employers may also choose to make contributions.
Pros of FSAs
FSAs can be used with any type of employer-sponsored health plan, but they are not compatible with Marketplace plans. Although employees often fund FSAs themselves, they can use pre-tax dollars to do so, thereby reducing the income taxes that they owe while helping them to budget for out-of-pocket health care expenses.
Cons of FSAs
FSAs operate on a use-it-or-lose-it basis. If employees do not use the funds by the end of the year, the funds expire. However, employers can opt to provide a limited rollover amount if they want to do so. Alternatively, employers may offer a grace period of up to two and a half months during which the funds remain available.
Health Reimbursement Arrangement
A Health Reimbursement Arrangement (HRA) is an employer-owned account that reimburses employees for eligible health care expenses. Employees typically do not owe taxes on the reimbursements.
Some HRAs are offered in addition to group coverage. However, employers may also offer Individual Coverage HRAs (ICHRAs) in place of group coverage. Employers can then use the ICHRA allowance to purchase health insurance and pay health insurance premiums.
HRA Account Pros
HRAs can be combined with any type of employer-sponsored plan or used in place of group coverage, so they are highly flexible. Additionally, there are no annual contribution limits, so employers can be as generous as they want.
Cons of HRAs
Only the employer can contribute to an HRA. Additionally, the funds typically expire if they are not used, although employers can allow funds to roll over if they choose to do so. HRAs are not portable, so employees lose access if they switch jobs or retire.
Which should you offer?
Each type of health account has advantages and disadvantages. The best one will depend on the circumstances and priorities of your organization and your workforce, but when deciding between accounts, consider the following questions:
- Who will fund the account? If only the employer will fund the account, an HRA is possible. However, if the employee will be responsible for providing some or all of the funds, an HRA is not possible.
- Who will own the account? If the employer wants to own the account, either an FSA or HRA could work. If you want the employee to own the account, an HSA is likely the best fit.
- What type of health plan does the employee have? HSAs are designed to work with high-deductible health plans, and only individuals who are enrolled in such plans can open HSA accounts or make contributions. If an employee is enrolled in a high-deductible health plan, an HSA may be a good option. However, if your employees are enrolled in other types of health plans, you’ll need to go with an FSA or HRA option.
- Do you want an account that helps with both health care costs and retirement savings? HSAs pull double duty because the funds earn interest and never expire. As a result, this can be an attractive benefit option for many different types of employees, whether they’re more focused on immediate health care costs or long-term savings goals.
- Do you want an alternative to group health insurance? If you want to provide an account instead of offering a group health plan, ICHRAs are an option. This can be a way of simplifying your employee benefits while still providing health coverage for your workers.
If you need help choosing between an HRA vs. HSA vs. FSA, Higginbotham can help. We’ll work with you to put together an employee benefits package that helps to meet the needs of your business and your employees. Learn more.