As the price of healthcare continues to increase, employers can assist employees by providing employees the opportunity to enroll in special accounts to help pay for medical expenses. Some of these accounts enable the employer to share the cost burden with the employee while providing tax-savings to each. Generally, there are three (3) employer-sponsored vehicles that are commonly used to help pay for qualified medical expenses: (1) Health Reimbursement Arrangement (“HRA”), (2) Flexible Spending Account (“FSA”), and (3) Health Savings Account (“HSA”). Each of these vehicles allow the account holder to use the contributions to pay for qualified medical expenses, yet each differs in key areas.
What is a Health Reimbursement Arrangement?
An HRA is an employer owned and funded plan that reimburses employees for qualified medical expenses. In some instances, depending on how the employer has the plan set up, an HRA can be used to pay health insurance premiums. Any reimbursements made by an HRA are generally tax-free for the employee and tax deductible for the employer. Because an HRA is owned by the employer, the employer controls which expenses are covered by the plan.
Unused HRA funds can either roll over for use in the next year, or the employer can impose a “use it or lose it rule. A “use it or lose it rules” means that any money left in the plan either after the end of the year or when the employment relationship ends reverts back to the employer. However, employers may allow former employees to have access to their HRAs. Finally, HRAs are funded through employer contributions and employees cannot contribute additional monies to their account.
What is a Flexible Spending Account?
Like an HRA, an FSA also allows employees to reimburse themselves for qualified medical expenses. These reimbursements are tax-free if used for qualified medical expenses. However, an FSA is owned by the employee and can be funded by both employer and employee contributions. Employee contributions are made on a pre-tax basis and taken directly from the employee’s paycheck. The employer creates this arrangement through a “cafeteria plan” and is considered the FSA “sponsor.”
The main difference with FSAs is that the accounts are subject to the “use it or lose it” rule. However, employers do have a little wiggle room. They can either (a) provide a “grace period” of up to two-and-a-half (2 ½) months to use the unused balance or (b) allow employees to carry up to $610 for 2023 and $640 for 2024 into the next plan year. Finally, and unlike an HRA, an employer cannot allow an employee to participate in an FSA after the employment relationship has ended.
What is a Health Savings Account?
Like the previous two plans, an HSA is used to cover the costs of qualified medical expenses. Similar to an FSA, an HSA can be funded by the employee and/or the employer, and just like the other two plans, the contributions are tax deductible and distributions for qualified medical expenses are not taxed. However, while HSAs are also owned by the employee, the employer normally does little else beyond remitting an annual contribution. As a result, the HSA follows the employee after the employment relationship has ended. An HSA also differs from an HRA and FSA as it is only available to employees participating in high deductible plans.
How much Can You Contribute Under Each Plan?
The federal government limits the amount that can be contributed to each plan during the applicable year. Not only do these limits vary depending on the type of plan and the year, but the limits also vary based on whether on whether the participant has self-only or family coverage. The current limits for 2023 and 2024 are as follows:
In addition to the contribution limits listed in the table above, the government allows employees participating in an HSA and are who are 55 or older to make “catch-up” contributions of $1,000 per year.
Using these accounts to help pay for medical expenses can be an effective tool to lower the employees’ out-of-pocket health care costs while reducing employees’ income tax. When choosing whether to offer one of these employer-sponsored health care funding vehicles, employers should consider (1) what other health benefits they provide to their employees, such as whether the employer-sponsored health insurance makes health care affordable for employees, (2) how much funds employees may need for adequate healthcare, (3) the health care purposes for which employees may need funds, and (4) the amounts the employer can afford when providing additional health care funds to employees. If the employer cannot provide much additional funding for employees’ health care, an FSA or HSA may be the best option to allow employees to contribute and thus reduce their tax burden.