HSA vs. FSA vs. HRA: All of these options can be confusing. We cover what each of these tax-advantaged accounts is and how to use them.
The IRS allows three types of healthcare-related savings plans: HSAs, FSAs, and HRAs. All three are generally earmarked for medical costs. But they each have unique rules and regulations.
Health Savings Accounts (HSAs)
An HSA is essentially an IRA for healthcare expenses. You make tax-deductible contributions to the plan, and you can withdraw the funds to pay for approved medical costs.
And just like an IRA, you can also invest the funds held in an HSA. You can invest them in investment vehicles similar to IRAs, including stocks and mutual funds. The earnings grow on a tax-free basis, as long the funds are retained in the plan. You can withdraw any funds from the plan without paying taxes or penalties, as long as you use the distributions for approved medical costs.
Where an HSA departs from an IRA is when distributions are taken for nonmedical expenses. In that situation, distributions are subject to both ordinary income tax and a 20 percent IRS penalty.
Contributions to an HSA can be as high as $3,400 for an individual and $6,750 for a family in 2017. The IRS also allows a catch-up contribution of $1,000 per year for those who are age 55 or older. If you don’t use all the funds during the year, you can roll them forward indefinitely.
But here’s the catch: you can only use an HSA in conjunction with a high-deductible health insurance plan. In 2017, a high-deductible health insurance plan has an annual deductible of at least $1,300 for self-only coverage or $2,600 for family coverage.
At the same time, there are maximum limits on total out-of-pocket expenses within the health insurance plan. For 2017, those limits are $6,550 for self only coverage, or $13,100 for family coverage. These expenses include copayments, coinsurance and deductibles, but not the actual premiums paid for your health insurance.
Where to Open an HSA
Consumers typically open HSAs with a bank or credit union, but some brokerage firms also offer these accounts. You can set up an HSA through your employer, but you can also start one on your own. One you open an account, the issuer will typically provide you with checks and a debit card so you can pay your medical bills as they occur.
The Benefits of Having an HSA
Perhaps the biggest benefit of an HSA is that it can enable you to get a tax deduction for medical expenses, even if you don’t itemize your deductions. And even if you do itemize, the IRS limits medical deductions to only the portion that exceeds 10% of your adjusted gross income.
That means that if you have $50,000 in adjusted gross income, you can only deduct medical expenses that exceed $5,000 ($50,000 X 10%). But with an HSA, you can deduct as much as $6,750 contributed to the plan, even if you don’t itemize.
Another major benefit is that if you accumulate a large HSA balance, you can roll the plan forward into retirement. That will give you a large account to pay medical expenses out of when you’re older and will presumably have higher healthcare costs.
Flexible Spending Arrangements (FSAs)
Similarly to HSAs, FSAs enable you to save money to pay for medical expenses, including dental and vision related expenses. Your contributions are tax-deductible. However, if you have funds left in the account at the end of the year, you forfeit them.
Depending upon your employer, there may be provisions that will allow you to keep at least some of the funds. For example, some plans will allow you to carry up to $500 into the following year. Others might extend use of the funds for up to 2 ½ months into the following year. However, not all employers offer either option.
Individuals can contribute up to $2,600 to an FSA in 2017. If you make contributions as an employee, they’re tax-deductible. However, your employer can also contribute to your account. Your employer may also split the contribution with you, depending on your benefits structure. The employer can also offer an employer match of up to $500. You can also open an FSA on your own, through a bank or credit union.
Much like an HSA, your account will typically also come with either a checkbook, a debit card, or both. Similarly to an HSA, the funds in your FSA must be used to pay for uncovered medical expenses, such as copayments, coinsurance, and deductibles. However, an FSA can also be used for procedures generally not covered by health insurance plans, including birth control, pregnancy tests, insulin, crutches, chiropractic treatment and smoking cessation programs.
Who Can Benefit from a FSA?
Since neither the contributions nor the terms of an FSA are as generous as they are for HSAs, you should only take an FSA under certain circumstances. For example, if your health plan doesn’t qualify for an HSA, an FSA can be a good substitute. But you need to be sure that you only contribute as much as you’ll actually use in a year. It’s better to have your FSA fall short of your healthcare expenses, so that you pay some out of pocket post-tax, than it is to lose money.
Typically, employers will offer FSAs. However, if the HSA is available, you’re better off going with that option.
One other item of note: if anyone in your family uses an FSA, that will disqualify all family members from using an HSA. Find out more about that issue in this article.
Health Reimbursement Arrangement (HRAs)
An HRA is a plan in which your employer reimburses you for medical expenses. This can include out-of-pocket medical costs. But unlike an HSA or an FSA, HRA funds can also be used to pay for health insurance premiums. Another important distinction is the fact that an HRA is a reimbursement arrangement. That means that you can only be reimbursed for actual expenses incurred.
The specific medical expenses eligible for reimbursement under an HRA are outlined in IRS Section 213 of the Internal Revenue Code. However, your employer can reduce that list if they so choose. Also, some plans may allow you to roll over your unused HRA balance to the next year, while others won’t.
The employer, not the employee, owns the HRA plan. The plan is funded entirely by the employer, therefore there is no tax deduction for contributions by the employee. There is no limit on how much an employer may put into an HRA. And like an HSA, the employee will usually receive a debit card to access the plan.
Unlike an HSA, you cannot invest funds held in an HRA. Though it’s not possible to set up an individual HRA, you can get a small business HRA if you’re self-employed.
What is the Benefit of an HRA?
Probably the biggest benefit of an HRA is that it allows the employee to choose which health care expenses to reimburse. The employee can choose between actual out-of-pocket medical costs or health insurance premiums.
There is no tax benefit to the plan, but there is no cost to fund the plan on the part of the employee. If an employer offers an HRA, the employee should certainly take advantage of it.
An HSA and an HRA are almost always worth doing if they are available through your employer. But you can also set up an HSA on an individual or family basis, which is certainly worth considering if you have high medical expenses. You should consider an FSA only as an alternative to an HSA. Just be sure you’ll have enough medical expenses to use up your full contribution to the plan! However, if your employer is paying the full cost of the FSA, then it’s definitely worth having since there is no cost to you.