HSA vs. FSA vs. HRA

A younger Mary Lou Daly

I was not part of the “in” crowd during middle school.  I could not dribble a basketball and run at the same time.  I could not do a backflip or a split. My hair was cut like Dorothy Hamill’s, but that did not seem to be enough. (For the younger generation, Dorothy Hamill was a figure skater who won the 1976 Olympic gold medal.)

I desperately wanted to fit in, but as the daughter of a preacher and a teacher, I was not sure how to “look and talk” like the “in” girls.  Ultimately, I decided that I needed braces and glasses.  Neither was physically necessary, but in my mind, they were a bridge to the popular kids.  I proceeded to borrow spacers from my friends in an effort to get my teeth to separate and tried to wear glasses hoping to confuse my eyes.  Luckily neither trick worked!

As an adult, I understand why my parents were secretly excited that I did not need glasses or braces.  Both are expensive medical costs that were not covered by our health insurance.  But at age 13, health insurance was not in my vocabulary. When I got sick, I went to the doctor and somehow the bill got paid.  It was that simple.

Today, as I read through our health insurance annual enrollment, I realize that healthcare accounts can be incredibly confusing.  And while we don’t profess to know the ins and outs of health insurance, we do want to make sure everyone understands the difference between a Health Savings Account (HSA), a Health Reimbursement Arrangement (HRA), and a Flexible Spending Account (FSA) because these accounts have potential tax saving benefits. The key differences are their ownership, funding, and requirements.

Health Savings Account

Health Savings Accounts (HSAs) are special accounts funded with pre-tax dollars to pay for or reimburse you for qualified medical expenses. You must have a High Deductible Health Plan (HDHP) in order to contribute to an HSA.

An HSA is portable. It is set up by you, belongs to you, and stays with you even if you change jobs. You or your employer can contribute, though you can still set up an HSA and make contributions if you are self-employed or unemployed, provided you are covered by an HDHP. The IRS also allows other people to make contributions on your behalf.

Regardless of who makes them, total contributions need to stay under the annual limit.

The maximum HSA contribution for 2021 is $3,600 for self-only health insurance coverage and $7,200 for family health insurance coverage. Individuals over the age of 55 may contribute an additional $1,000 annually. This limit applies to all contributions made by you or on your behalf during the calendar year. All contributions become the property of the HSA owner once deposited, including contributions by your employer. When completing your annual enrollment paperwork, your employer will ask how much you would like to contribute to your HSA.  If you change your mind later in the year, you can change your contribution amount.

Continued medical coverage under a HDHP is not a requirement to use money in your HSA. In the years when you do not have medical coverage under a HDHP, the HSA account continues to exist and is available to use, even though you cannot make contributions to it.

If you have adequate cash flow, you may choose to pay your current medical expenses out of pocket and invest your HSA contributions for use towards medical costs during leaner times or in retirement. If invested, the account value will increase and decrease based on the underlying investments. The ability to invest pre-tax dollars into an HSA, grow them tax free, and draw them out tax free for qualified medical expenses is what makes this type of account so advantageous. For more on HSAs and their benefits, please see my previous article Health Savings Accounts:  Desirable Despite the Complexity.

Health Reimbursement Arrangements

Health Reimbursement Arrangements (HRA) are accounts established, owned, and funded by your employer.  The employer determines how much to put into the account each year.  There are no government limits for employer contributions. Employees are reimbursed for qualified medical expenses and health insurance premiums up to an amount determined by the employer. Like HSAs and FSAs, reimbursements are tax free to the employee if the reimbursement is for HRA-eligible medical expenses as determined by the employer. While generally these are the medical expenses detailed in IRS Publication 502 Medical and Dental Expenses, ultimately the employer determines what medical expenses will be reimbursed (see IRS Pub. 969 Health Savings Accounts and Other Tax-Favored Health Plans). Because the accounts are owned by the employer, they are not portable. When you leave your employer, the funds for your benefit are no longer available to you.

If you have access to an HRA and an FSA, expenses are typically paid by the HRA first.  When those dollars run out, the FSA is used.  An “individual” HRA is available whereby employers can provide an employee funds to purchase their own health insurance and reimburse for qualified medical expenses. Any unused amounts in the HRA can be carried forward and used in later years if the plan allows.

Flexible Spending Account

Flexible Spending Accounts (FSA) are accounts established by your employer to cover qualified medical expenses as defined in IRS Publication 502. Self-employed persons are not eligible to set up FSAs.

Similar to the HSAs, they are funded with pre-tax dollars.  You do NOT need to have health insurance to participate in an FSA.  You and your spouse can each have an FSA with your respective employers. The 2021 contribution limit is $2,750.  A dual-income family, where both employers offer an FSA, can contribute up to $5,500. FSAs are unique in that you can have a negative balance during the year. In other words, you can pay for medical bills using FSA funds prior to having the money withdrawn from your paycheck.

If you participate in an HSA, you are not eligible for a medical FSA but you may be able to also participate in a Limited Purpose FSA (LPFSA).  A LPFSA can only be used for vision care and dental expenses as defined in IRS Publication 502.

Note that there is also a dependent care FSA.  A dependent care FSA helps pay for qualified childcare for children younger than thirteen and eldercare expenses for adult dependents who are incapable of caring for themselves.  The care must be needed so that you may work or so that someone on your plan, such as your spouse, can look for work or go to school. IRS Publication 503 defines qualified dependent care expenses. Annual contribution limits for dependent care FSAs are $2,500 for an individual or $5,000 for a family. These limits are separate from the medical FSA limits.

FSA dollars are not portable between employers and typically cannot be carried over into the next year (you may have heard the phrase “use it or lose it”).  Some healthcare and limited FSA plans have adopted recent changes allowing you to carry over approximately $500 into the next year or allowing you to use the dollars during the first 2.5 months of the following year. Dependent care FSA dollars must be spent during the year. (Details differ for each plan regarding when receipts must be provided for reimbursement and if any of the accounts can be carried over into the next taxable year.) Annually you elect your FSA contribution.  Changes are only allowed if you have a change in employment or a change in family status.

During open enrollment, be sure to read the fine print to learn more about the healthcare accounts your employer offers.  During my teen years, my parents would have benefited by making contributions to a HSA and participating in a LPFSA.  What are your family needs for the upcoming year?

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.