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HSAs, HRAs, and FSAs: What You Need to Know

By Kate Rockwood | September 15, 2020 | Rally Health

FSA? HSA? HRA? Before the alphabet soup of health care savings plans makes you shut down, let us offer this PSA — ahem, public service announcement: Understanding how a health savings account (HSA) works could save you serious money, whether you have major medical bills this year or not. “This is one way to take control of the rising cost of health care,” says Todd Berkley, author of “HSA Owner’s Manual.”

And rise it has: As employers have shifted more cost-sharing to employees, high-deductible health plans have become more common, Berkley says, and out-of-pocket expenses have climbed. On average, a single individual paid $1,655 toward a deductible in 2019, up from $826 a decade earlier, according to the Kaiser Family Foundation. That means the average person is shelling out over $800 more for covered health care services before their insurance plan starts to pay.

For consumers, HSAs can be a savvy way to sock away money, tax free, in case they need to pay that high deductible. Flexible Spending Accounts (FSAs) are another option to defray health costs by setting aside untaxed income for eligible medical expenses. HRAs are yet another health account tool that some employers use to provide funds for health care. But what type of health account makes sense for your situation? We’ve got you covered:

What is an FSA?

You’re probably already familiar with an FSA, which is a health-related spending account: You estimate how much you’ll spend on out-of-pocket medical expenses that year, then have your employer set that amount into a separate, tax-free account to be used when you need it. If you max out the $2,750 cap and have a 30% tax rate, that FSA could save you $825 in taxes.

Of course, that assumes you use every dollar you’ve set aside. FSAs are often scorned for being “use it or lose it” — meaning you lose any funds you don’t spend that year (or sometimes early the next year). So if you overestimate your expenses, you could potentially lose more money than you save in taxes.  

What’s an HSA?

HSAs also allow you to spend pre-tax dollars on medical expenses, but the similarities pretty much end there, says Matthew Clarkin, president of the consulting firm Access Point HSA. With an HSA, you choose how much you want to save each year (and in some cases take advantage of employer-matched contributions), and that money gets deposited into a special account. But instead of expiring after a year, those funds can be invested and rolled over from one year to the next, and can even be used for non-health expenses once you reach retirement age. 

That puts an HSA more in line with long-term savings accounts, like a 401(k), than a simple spending account, says Clarkin. “It’s a tool that can help you with deductibles now, but used correctly, can also have substantial long-term benefits — like saving for big expenses in retirement without being subject to the same taxes your 401(k) might be.” Starting at age 65, you can withdraw the money for an expense of any type, not just health care related, without penalty, potentially letting you delay withdrawing money from retirement accounts like a 401(k) or IRA. 

In fact, HSAs have three separate tax benefits: The money you deposit into the HSA is either pretax dollars (if made through a payroll deduction) or tax deductible (if you make the deposits yourself). Then, the funds that are in your HSA account aren’t taxed as they grow. And when you withdraw the original funds, you don’t have to pay taxes on that portion either — as long as you’re using them for approved health expenses. You can use your HSA for non-health- related expenses in retirement, too, but you do pay income tax on those.

These tax benefits have made them popular. Last year, more than 28 million Americans jumped on the HSA bandwagon — a 13% increase from the year before, according to an annual survey by the industry research firm Devenir.

Who Qualifies? HSAs are available to any individual who has what the IRS considers to be a high-deductible health plan — meaning an annual deductible of at least $1,400 for individuals and $2,800 for families. If you qualify, you are able to contribute $3,550 annually for self-coverage or $7,100 for families. Individuals 55 and older are allowed an additional contribution amount of up to $1,000.

Keep in mind that once you have an HSA it’s yours to keep — even if your next job doesn’t have a high-deductible plan, explains Clarkin. “Millennials have a greater tendency to move around and change jobs, and they can take the HSA with them wherever they go.”

Where You Sign Up. HSAs are offered as a benefit of employment by 83% of large employers, and this is your best bet to get those matched contributions. However, if your employer doesn’t  offer an HSA, you can also apply for one through a bank, credit union, or private broker that specializes in health insurance. The IRS also has HSA trustees who can answer your questions by phone (1-800-829-1040 for individuals; 1-800-829-4933 for businesses).

How HSAs Work. When there is an eligible medical expense, your savings are immediately available to you, linked to a debit card or personal checks. Monthly insurance premiums are not eligible, but qualified expenses include deductibles, copays, coinsurance, medical equipment, prescriptions, even dental and vision costs.

However, it’s worth noting that you don’t have to spend your HSA funds on those health expenses. “If you can afford to maintain those costs out of pocket, that can sometimes be the smartest long-term move,” says Roger Wohlner, a financial planner and author of “The Chicago Financial Planner.” That’s because every time you shoulder an expense out of your paycheck and leave the HSA funds untouched, you’re leaving more money to grow — tax free — for longer.

And your gray-haired self may one day thank you: “People tend to dramatically underestimate their health care costs in retirement,” he says. “And long-term care costs are rising faster than inflation.” Wohlner points out to clients that an HSA compounds and continues to avoid taxes, even the capital gains tax, as long as you spend only on health-related costs when you finally use it.

What are the downsides of an HSA? There can be a learning curve figuring out how to proactively save for and manage higher out-of-pocket costs. “But we find that once people get through the first year, most people are really satisfied with this type of account,” says Berkley.

Still, high-deductible plans and HSAs aren’t for everyone. Depending on your health conditions, your tax rate and your tolerance for juggling health bills and accounts, it might make more sense to stick with a traditional plan. Keep in mind that for an HSA to work, you have to set aside enough money to fund it, or you could find yourself skimping on necessary medical care when faced with a big bill. A report by Families USA showed that 30% of individuals with deductibles above $1,500 were more likely to avoid needed care.

What is an HRA?

An HRA, which stands for health reimbursement arrangement or health reimbursement account,  is an employer-funded account that can be used to reimburse eligible medical expenses that aren’t covered by your insurance. Qualified expenses include deductibles, copays, coinsurance, medical equipment, prescriptions, even dental and vision costs. Your employer may offer this account along with a health plan, or to help you cover expenses (including the premium) for an individual health plan you find on your own. 

Unlike an FSA or HSA, only your employer can make contributions to an HRA. Your employer decides how much to contribute and whether the unused balance rolls over every year. There is no maximum amount an employer can contribute, but in 2019, the average employer contribution to an HRA was $1,713 for individuals and $3,255 for families, according to the Kaiser Family Foundation’s 2019 Employer Health Benefits Survey

New rules that kicked in on January 1, 2020 greatly expanded who is eligible for an HRA and how they can be used. Previously, HRAs could be offered only by employers who provided group health insurance and then only to the employees who were enrolled in their insurance. The changes created an Individual Coverage HRA, for companies that don’t provide group health insurance to offer employees to use with their own health plan, and an Excepted Benefit HRA, which can be offered to employees who turn down their employer’s group health insurance. 

The money in the Individual Coverage HRA can be used to buy your own health insurance either on or off the Affordable Care Act (ACA) exchange. The Excepted Benefit HRA, meanwhile, reimburses you up to $1,800 a year for qualified health expenses. It can’t be used to buy health insurance, but short-term health insurance, and dental and vision premium expenses qualify. Depending on your income and the plan you’re offered, it might be worth seeing if you save more with a Marketplace plan from your state’s Affordable Care Act exchange than with your HRA. If you have an HRA notice from your employer, you can enter information in this tool to compare to health plans. 

Who qualifies? HRAs are open to employees as well as employees’ spouses and dependents, with some limits. If you have a child younger than 27 they can be included, too. Spouses and dependents of deceased employees also are eligible. If your employer doesn’t offer group health insurance, then you would only be eligible for an Individual Coverage HRA.

You can enroll in an HRA during your employer’s open enrollment period or if you have a qualifying life event.

HRAs vs. HSAs

The biggest difference between an HRA and an HSA is that an HRA is owned by your employer and an HSA is owned by you. With an HRA, your employer decides how much to contribute, and which of the IRS-approved medical expenses will qualify for reimbursement. And unlike an HSA, an HRA is owned by your employer, so you can’t take it with you if you leave your job or retire. 

With an HSA, both you and your employer can make contributions to the account. With an HRA, only your employer can contribute. And because the money in an HRA isn’t yours, you can’t invest it.

To be eligible for an HSA, you must be enrolled in a qualified High Deductible Health Plan. For an HRA, you may be eligible if you’re on your employer’s insurance, you’ve turned down your employer’s insurance, or your employer doesn’t offer insurance and you want to buy your own. But aside from HRA reimbursements being tax free, it lacks the tax breaks of an HSA.

Tax breaks are great — and for savvy savers, an HSA offers plenty of them — but that’s not the only thing to consider when choosing a health plan. If you’re concerned about your ability to fund and manage an HSA, a traditional health care plan supplemented with an FSA or HRA may be the wiser choice.

Originally published in October 2017. Updated in September 2020. 

Kate Rockwood
Rally Health