Consumer-directed health accounts: FSA, HDHP/HSA, and HRA

What "consumer-directed" means

Traditional health plans pay most bills from the first dollar, and the member sees little of the cost. Consumer-directed health care gives the member a pot of tax-favored money and the job of spending it wisely on routine care. Three arrangements dominate the exam: the flexible spending account (FSA), the health savings account (HSA) paired with a high deductible health plan (HDHP), and the health reimbursement arrangement (HRA). All three pay qualified medical expenses with money that is never taxed. The exam questions come down to three things: who puts the money in, who owns it, and what happens to it at the end of the year.

The tax rule underneath all three

Normally, health benefits an employer pays for count as the employee's income (26 U.S.C. § 105(a)). The exception is money paid to reimburse medical care for the employee, spouse, dependents, or a child under age 27. That money is not income (§ 105(b)). FSAs and HRAs are built on this exclusion.

Flexible spending account (FSA)

• Funded by the employee, through pre-tax salary reduction under the employer's

cafeteria plan. The employer may add money too.

• Owned by the employer's plan. The employee does not own the account.
• Use it or lose it. Money not spent by the end of the plan year is forfeited. An

employer may soften this with a short grace period or a limited carryover, but not both.

• Uniform coverage. The full annual election is available from the first day of the

plan year, even before it has all been withheld from pay.

• Not portable. Leaving the job generally ends the FSA.
• No special medical plan required.

A limited-purpose FSA covers only dental and vision care. Because dental and vision coverage is disregarded under the HSA rules, a person may have one alongside an HSA (§ 223(c)(1)(B)(ii)). A general-purpose FSA, by contrast, makes a person ineligible to contribute to an HSA.

High deductible health plan and health savings account (HDHP/HSA)

An HSA is a trust set up only to pay the account beneficiary's qualified medical expenses (§ 223(d)(1)). To contribute, a person must be an eligible individual: covered by an HDHP on the first day of the month, and not covered by any other health plan that is not an HDHP and covers the same benefits (§ 223(c)(1)(A)). Coverage for accidents, disability, dental, vision, long-term care and telehealth does not count against this rule (§ 223(c)(1)(B)). Neither does permitted insurance such as specified-disease or fixed per-day hospital indemnity coverage (§ 223(c)(3)). A person enrolled in Medicare can no longer contribute.

The HDHP. The plan must have a minimum annual deductible and a cap on the deductible plus other out-of-pocket costs. The statute's base figures were $1,000 deductible and $5,000 out-of-pocket for self-only coverage, doubled for family coverage (§ 223(c)(2)(A)). These amounts are indexed for inflation every year, so current limits are higher. An HDHP may cover preventive care, telehealth and insulin before the deductible (§ 223(c)(2)(C), (E), (G)). Bronze and catastrophic plans bought on an Exchange also count as HDHPs (§ 223(c)(2)(H)).

Contributions.

• Anyone may contribute: the individual, the employer, or a family member. Contributions

must be in cash (§ 223(d)(1)(A)).

• The individual's own contributions are deductible (§ 223(a)). The employer's are

excluded from the employee's income (§ 106(d)). Both count toward one annual limit (§ 223(b)(4)(B)).

• The limit is set monthly, one-twelfth of an annual amount for each month the person is

eligible (§ 223(b)(1)-(2)). The statute's base amounts were $2,250 self-only and $4,500 family, and they too are indexed each year.

• From the year a person turns 55, they may add a $1,000 catch-up contribution

(§ 223(b)(3)).

Ownership. The trustee must be a bank, an insurance company, or another approved custodian. The account cannot be invested in life insurance, and the owner's interest is nonforfeitable (§ 223(d)(1)(B), (C), (E)). The money belongs to the individual, rolls over from year to year with no limit, and stays with them if they change jobs.

Triple tax advantage.

1. Contributions go in deductible or pre-tax.
2. The account grows free of tax (§ 223(e)(1)).
3. Withdrawals for qualified medical expenses are tax-free (§ 223(f)(1)).

A withdrawal not used for qualified medical expenses is taxable income (§ 223(f)(2)). Before age 65 it also carries a 20% additional tax. After 65, at disability or at death, that additional tax does not apply. The withdrawal is still taxed as income unless it paid medical bills.

Insurance premiums generally cannot be paid from an HSA. The exceptions are COBRA or other federal continuation coverage, qualified long-term care insurance, a health plan while receiving unemployment compensation, and, from Medicare age, health coverage other than a Medicare supplement policy (§ 223(d)(2)(B)-(C)).

Moving and inheriting. Money may be rolled from one HSA to another within 60 days, once a year (§ 223(f)(5)). An HSA transferred to a spouse in a divorce is not taxed (§ 223(f)(7)). A surviving spouse named as beneficiary simply becomes the new owner. For any other beneficiary, the account stops being an HSA at death (§ 223(f)(8)).

Health reimbursement arrangement (HRA)

• Funded only by the employer. Employees cannot put in salary reductions.
• Owned by the employer, which decides the annual amount and what it covers.

Reimbursements of medical care are tax-free to the employee (§ 105(b)).

• Rollover is the employer's choice. The plan may let unused amounts carry forward.
• Usually not portable. Leaving the job generally ends access.
• No HDHP required.

Variations include the qualified small employer HRA for small employers that do not offer a group health plan (§ 106(g)). The individual coverage HRA reimburses premiums for individual health insurance. Both FSAs and HRAs may now reimburse menstrual care products as medical care (§ 106(f)).

Keeping them straight

FSA: employee funds, employer owns, use it or lose it. HSA: anyone funds, individual owns, keeps forever, requires an HDHP. HRA: employer funds, employer owns, employer decides rollover.