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

Three ways to pay medical bills with tax-favored dollars

Consumer-directed health accounts give the patient (the consumer) a pot of money to spend on medical care, so that people see and weigh the cost of care themselves. The exam tests three of them: the flexible spending account (FSA), the health savings account (HSA) paired with a high deductible health plan (HDHP), and the health reimbursement arrangement (HRA). Learn each one by four questions: who funds it, who owns it, what happens to unused money, and what coverage must go with it.

A chart with three side-by-side columns comparing the accounts. The first column, flexible spending account, says it is funded by the employee's pre-tax pay with optional employer money, owned by the employer's plan and not portable, subject to use it or lose it with an optional grace period or carryover, and requires no particular health plan. The middle column, health savings account, says anyone may contribute in cash with a one thousand dollar catch-up at age fifty-five, the individual owns it and it is nonforfeitable and portable, unused money rolls over forever and can be invested, and it requires a high deductible health plan. The third column, health reimbursement arrangement, says only the employer funds it, the employer owns it and it is generally not portable, unused money carries over only if the employer allows, and it requires no particular health plan. — FSA, HSA and HRA compared: funding, ownership, unused money, required plan

Flexible spending account (FSA)

A health FSA is an employer-sponsored benefit offered through a Section 125 cafeteria plan.

Funding: mainly the employee, through pre-tax salary reduction elected before the plan year. The employer may also contribute. Salary reductions are subject to an annual dollar limit that is indexed for inflation.
Ownership: the account belongs to the employer's plan, not the employee. It is not portable; it generally ends when employment ends.
Uniform coverage rule: the employee's full annual election is available from the first day of the plan year, even before it has all been deducted from pay.
Unused money: the traditional "use it or lose it" rule. Leftover money is forfeited at the end of the plan year, unless the employer adopts one of two relief options: a grace period of up to two and a half months to incur new expenses, or a limited carryover of a set dollar amount into the next year.
Coverage needed: none in particular. An FSA can sit alongside any health plan.

HSA paired with a high deductible health plan

An HSA is a tax-exempt trust or custodial account held for one person, the account beneficiary, to pay qualified medical expenses.

Eligibility: for any month, you must be covered by an HDHP on the first of the month and have no other health coverage that duplicates it. Coverage such as accident, disability, dental, vision, long-term care, specified-disease or fixed hospital-indemnity insurance is disregarded. You also cannot contribute once enrolled in Medicare, or if someone else may claim you as a dependent.
The HDHP: the plan must carry an annual deductible at least a statutory minimum and cap the deductible plus other out-of-pocket costs at a statutory maximum. Both figures are set higher for family coverage and adjusted for inflation each year. Preventive care may be covered before the deductible without breaking HDHP status.
Funding: the individual, the employer, or anyone else may contribute, in cash only, up to an annual limit (higher for family coverage). People age 55 or older may add a $1,000 catch-up contribution. The individual deducts his or her own contributions; employer contributions are excluded from income.
Ownership: the individual owns it. The balance is nonforfeitable, so it stays with the person when they change jobs or plans.
Unused money: it rolls over indefinitely and may be invested (but never in life insurance).
Withdrawals: tax-free when used for qualified medical expenses. Otherwise they are taxable income plus a 20% penalty, and the penalty does not apply after death, disability, or age 65. Insurance premiums are generally not qualified expenses, with exceptions such as COBRA continuation coverage, coverage while on unemployment, qualified long-term care insurance, and, from age 65, Medicare premiums.

This combination of deductible contributions, tax-free growth, and tax-free qualified withdrawals is often called the HSA's triple tax advantage.

Health reimbursement arrangement (HRA)

An HRA is an employer promise to reimburse an employee's medical expenses up to a set amount each year.

Funding: employer only. Employees cannot contribute, and it cannot be funded by salary reduction.
Ownership: the employer. Reimbursements for medical care are excluded from the employee's income.
Unused money: the employer decides whether unused amounts carry over to the next year. The arrangement is generally not portable when the employee leaves.
Coverage needed: no HDHP is required, though an HRA is often paired with one.

Exam shortcut: FSA = employee's pre-tax pay, use it or lose it. HSA = individual owns it, must have an HDHP, rolls over forever. HRA = employer money only, employer sets the carryover rules.