Choosing the Right Health Savings Plan

March 4, 2024

When it comes to selecting a health savings tool for your family, you have a few great options. In the following guide, we provide a basic overview of Health Savings Accounts (HSAs), Health Reimbursement Arrangements (HRAs), and Flexible Spending Accounts (FSAs), including the features of each and the similarities and differences among them, so you can choose the right health savings tool for your family. Read on to learn more.

What is a health savings account (HSA)?

A Health Savings Account (HSA) is a tax-advantaged account for individuals who participate in high-deductible health plans (HDHPs) to help them save for eligible medical expenses. HSAs are tax-advantaged savings tools because contributions made by either the employer or the employee are tax-free, as are the HSA’s earnings as well as the distributions used to pay for eligible medical, dental, vision, and pharmacy expenses. HSAs are owned by the individual for whom they were created, and as such, are portable savings tools if the individual moves on from a current employer.

In order to qualify for an HSA, an individual must meet the following requirements set forth by the IRS:

  • Participates in a qualified high-deductible health plan (HDHP)
  • Has no other health coverage
  • Is not a recipient of Medicare
  • Is not claimed as a dependent on someone else’s tax return

HSAs may be offered by an individual’s employer, but if they are not, the individual may wish to open an account with a participating financial institution. Self-employed and unemployed qualifying individuals may open an HSA, and anyone else, such as a family member, can make contributions to an HSA on behalf of the qualified account owner. Contributions to an HSA that is not offered by the employer can only be made in cash.

The IRS places a maximum annual contribution limit for HSAs. For 2023, the maximum contribution limit for an individual is $3,850 and for a family is $7,750. The annual limits apply to the total amount contributed by the employer and the employee. Individuals aged 55 or older by the end of the tax year are permitted to make annual catch-up contributions of an added $1,000 to their HSAs.

HSAs offer the following advantages:

  • ✅ Tax-free contributions (up to a certain limit), earnings, and distributions (for qualified medical expenses)
  • ✅ Individual owns the account regardless of employer or employment status
  • ✅ Contributions are vested, and unused account balances roll over to the following year
  • ✅ Funds in an HSA can be used to invest in stocks and other securities for potential long-term growth
  • ✅ Individual can appoint their spouse as the designated beneficiary, so the HSA can be transferred to the surviving spouse upon the individual’s death

HSAs also present a few disadvantages:

  • ⛔️ Only individuals who participate in qualified high-deductible health plans can open an HSA
  • ⛔️ HSAs come with filing requirements for contributions, specific regulations for withdrawals and distributions, and a record-keeping burden that may be cumbersome
  • ⛔️ In most cases, you cannot pay monthly health insurance premiums with HSA funds with the exception of Medicare premiums, COBRA, and long-term care insurance

Overall, HSAs are an excellent health savings tool for those individuals who qualify.

What is a health reimbursement arrangement (HRA)?

Health Reimbursement Arrangement (HRA) is an employer-funded plan that reimburses employees for eligible medical, dental, vision, and pharmacy expenses. Employers can claim a tax deduction for reimbursements made through these arrangements, and generally the reimbursement funds received by the employee are tax-free. HRAs can be offered alongside a traditional health insurance plan, and they are 100% funded by the employer.

With an HRA, the employee must first pay out-of-pocket for the eligible medical, dental, vision, and pharmacy expenses for which he or she intends to be reimbursed. Then the employee must submit a request for reimbursement. The funds are reimbursed according to the eligibility guidelines set forth by the IRS.

Here are some advantages of HRAs:

  • ✅ HRAs are funded by employers, so if they are available, employees can take advantage of tax-free savings for eligible healthcare expenses
  • ✅ HRAs help individuals and their families cover the cost of a wide range of qualifying medical, dental, vision, and pharmacy expenses
  • ✅ HRAs have contribution limits but many employers allow unused funds to be rolled over to the following year, up to a certain amount
  • ✅ Unlike an HSA, you do not need to participate in a high-deductible health plan in order to benefit

Here are a few disadvantages of HRAs:

  • ⛔️ Since HRAs are employer-funded health plans, they are not portable should an employee leave the current employer
  • ⛔️ Only IRS-approved expenses are eligible for reimbursement through HRAs; employers can set additional limits on which types of expenses qualify
  • ⛔️ The individual does not own the account or funds therein; there are no opportunities for tax-free growth and investment

Overall, HRAs are another great health savings vehicle for individuals and their families, and if your employer offers an HRA, it would be a great idea to take advantage.

What is a flexible spending account (FSA)?

A Flexible Spending Account (FSA) is a spending account for different kinds of qualified expenses. There are three types of FSAs that may be available, depending on your employer, or your individual or family health plan:

  • Health Care FSA – Used for eligible medical expenses not covered by your health plan
  • Dependent Care FSA – Used for eligible dependent care expenses for dependents (age 12 and under or disabled of any age who are unable to care for themselves)
  • Limited-Purpose FSA – Used for eligible dental and vision expenses if you participate in a high-deductible health plan and have a Health Savings Account

Anyone with a health plan that includes FSAs can participate in a Health Care FSA. Those with qualified dependents and eligible dependent care costs can participate in a Dependent Care FSA. And those who participate in an HDHP and have an HSA can participate in a Limited-Purpose FSA.

With any type of FSA, the individual is the account owner. However, unlike HSAs, FSAs are not portable, so if an employee leaves a job, he or she forfeits the FSA with the current employer.

As with HSAs and HRAs, FSAs offer several advantages:

  • ✅ The individual owns the account, and both the employer and the employee can contribute
  • ✅ The contributions you make to an FSA are tax-free and so are the withdrawals, provided they are used for qualifying medical, dependent care, dental, or vision care expenses
  • ✅ Some employers may allow unused funds in a Health Care FSA to be rolled over to the following year up to a certain limit – different rules apply for Dependent Care FSAs and Limited-Purpose FSAs

FSAs come with a few disadvantages as well:

  • ⛔️ The accounts are non-transferable upon a change of employment status
  • ⛔️ Some kinds of FSAs cannot roll over unused funds to the following year, depending on the plan or the employer
  • ⛔️ FSAs are more limited than HSAs; the contributions do not grow tax-free, as they are not investments, and funds can only be used for eligible medical, dental, vision, and dependent-care expenses as outlined by the IRS

Again, FSAs can be an excellent health savings tool for individuals and their families, especially if they are the only health savings tool available to you.

Ultimately, which health savings tool, HSA, HRA, or FSA, is right for you and your family will depend on your eligibility and which plans are available to you. Each offers a unique set of saving advantages and disadvantages to consider. While a Health Savings Account provides the most flexibility and opportunity for tax-free contributions, growth, and distributions, not everyone can participate in such a plan.

The professionals at Honest Buck are here with the financial expertise you need to decide which tax saving strategies are best for your circumstances. Reach out to our team to discuss your financial needs. Contact us today.

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