FSAs, HSAs, or HRAs: What's Best for Your Business?

There are several options for managing benefit costs, including health savings accounts (HSAs), flexible spending accounts (FSAs), and health reimbursement arrangements (HRAs). When it comes to HSAs, FSAs, and HRAs, what are the best options for your business?

Understanding Your Health Spending Account Options

Although there may be similarities between them, HSAs, FSAs, and HRAs are different from one another, and each one has distinct benefits for you and your employees. Understanding the differences can help you determine which type of benefit account arrangement is the best solution for your HR needs and save you valuable time and money.

Health Savings Accounts (HSAs)

What Is a Health Savings Account?

HSAs are an elective benefit that an employer can offer as a way for employees to set aside tax-advantaged medical savings to pay for copays, deductibles, and other qualified medical expenses. But there's a catch: Only individuals who are (1) covered by a high-deductible health plan (HDHP) (and have no other disqualifying health coverage), as determined by the IRS, (2) not enrolled in Medicare and (3) do not qualify as a tax dependent of someone else are eligible for an HSA. Contributions are made into the account by the employee and/or the employer up to a maximum amount each year. For 2024, that amount is $4,150 for individual coverage and $8,300 for family coverage. An HSA works much like a standard checking account (often including a debit card), and it's up to the employee to track their contributions, expenses and reimbursements.

Who Is an HSA For?

HSAs are a suitable option for healthy employees who generally receive medical care for predictable, annual checkups and have infrequent medical needs. Employees covered by Medicare are not eligible to contribute to an HSA. However, HSA funds that have accrued when an employee was eligible for the HSA arrangement can be used to pay Medicare premiums when the employee turns 65.

"This is a great plan for your healthy workforce with low medical costs and your wage earners who are going to want to hold on to that money they set aside, tax-free," says Shannon Anderson, senior HR generalist at Paychex.

Whatever employees save in HSAs they can keep, grow tax-free, and then withdraw from, even years later. Those withdrawals are still tax-free as long as the money is spent on qualified medical expenses. Additionally, at age 65, withdrawals can be made penalty-free (still taxed as ordinary income) for any purpose.

Who Owns the Account?

HSAs are owned by the individual employee and follow the individual even if that person resigns, retires, or is terminated. This feature is one of the biggest differences between an HSA and an HRA, which is owned by the employer.

What Expenses Are Covered by a Health Savings Account?

Qualified medical expenses include most medical care such as dental, vision, and IRS eligible over-the-counter drugs. A few examples of expenses are:

• Office visit copays
• Health insurance deductibles
• Dental expenses (tooth extraction, fillings, etc.)
• Vision care (eye exams and eyeglasses)
• Prescription drugs and insulin
• Medicare premiums
• A portion of the premiums for a tax-qualified, long-term care insurance policy
• Hearing aids
• Imaging (X-rays, MRIs)
• Wheelchairs, walkers, and crutches

IRS Publication 502 provides a detailed list of covered medical and dental expenses.

Paychex partners with the HSA Store, which also provides an expansive list of items that are HSA-eligible, while also offering a means for employees to use their funds.

How To Use an HSA to Your Advantage

A high-deductible health plan with an HSA can save a business money because HDHP premiums generally are lower than traditional plans.

"Recent studies have shown that employers who are on a high-deductible (consumer-driven) health plan are more cost-conscious of what they are spending, therefore giving savings to themselves and their employer," Anderson says.

There are employer tax benefits as well. Reducing an employee's taxable income decreases your tax liability. The lower an employee's Federal Insurance Contributions Act (FICA) tax liability, the less you're required to pay.

Flexible Spending Accounts (FSAs)

What Is a Flexible Spending Account?

An FSA is an employer-established plan that pays for qualified medical expenses with pretax dollars, prior to federal withholding, FICA tax, or state withholding taxes (in most states) being applied to the amount deducted from the employee's pay. Employers and employees may both contribute to the FSA. Employees must submit a claim to get reimbursed from their FSA and may forfeit contributions as discussed below. There is a cap on the amount that can be contributed to an FSA each year.

Who Is an FSA For?

A medical FSA is a good choice for employees who expect to have out of pocket medical care costs and wish to pay for those expenses with pretax funds. Additionally, employees with a medical FSA have immediate access to the full amount they elected to contribute for the tax year, making it a good option for those who have medical expenses early in the plan year. FSAs cannot be used to pay Medicare premiums.

Who Owns the Account?

The employer owns the FSA. Once an employee terminated employment, he or she generally is no longer eligible to participate in the medical FSA (unless he or she elects continuation coverage) and will forfeit any unreimbursed contributions. Further, depending on the employer’s election, unused contributions are either forfeited or a portion can be carried over to the next plan year.:

• Grace period. You can elect to offer a 2.5-month grace period after the plan year ends for enrolled employees to claim reimbursement of FSA funds. If you offer the Grace Period, any contributions remaining after the Grace Period are forfeited. Remaining money stays with the employer. The Grace Period is not an option if you offer the Carryover option.
• Carryover. Alternatively, you can elect to allow employees to carry over up to $500 (you determine the limit up to this amount) of unspent FSA funds to next year's plan. Unspent FSA funds over this limit are forfeited to the employer. Carryover is not available if your FSA offers the Grace Period.
• Forfeiture. If you do not choose either the Grace Period or the Carryover options, all contributions which are unused as of the end of the plan year are forfeited.

What Expenses Are Covered by a Flexible Spending Account?

Except for Medicare premiums, an FSA covers many of the same qualified medical and dental expenses that are covered by an HSA. For a detailed list of what is and isn’t covered, review IRS Publication 502.

Paychex partners with the FSA Store, which also provides an expansive list of items that are FSA-eligible, while also offering a means for employees to use their funds.

With a Flexible Spending Account (FSA), Are Over-the-Counter Medications Eligible for Reimbursement?

Under the new CARES Act law, a section of the Affordable Care Act that prohibited FSAs, Health Savings Accounts (HSA), and Health Reimbursement Agreements (HRA) from reimbursing expenses for over-the-counter (OTC) medical products was reversed. Any OTC medical products purchased after Dec. 31, 2019, no longer require a prescription to be eligible for reimbursement. The new law also treats menstrual care products such as tampons, pads, sponges, and similar products purchased after Dec. 31, 2019 as qualified medical expenses.

How To Use an FSA to Your Advantage

Employee contributions to a medical FSA are made on a pretax basis. Pretax contributions from the employee reduce the employee's taxable income and tax liability. Employers are not required to pay the employer portion of the Social Security tax on the contributions employees make to their FSAs. Employees who have a HDHP paired with an HSA are only allowed to utilize a certain type of FSA, special conditions and restrictions generally apply. An employee can carry over up to $610 of unused health FSA money at the end of the year to apply to the next plan year. Any funds remaining in excess of $6100 will be forfeited to the plan.

Health Reimbursement Arrangements (HRAs)

What Is a Health Reimbursement Arrangement?

A health reimbursement arrangement is an employer-funded plan that supplements health insurance benefits and pays for a range of medical expenses not covered by insurance. HRAs are among the most flexible types of employee benefits plans. Unlike an HSA or FSA, employees cannot contribute to an HRA.

Who Is an HRA For?

An HRA is advantageous for all employees. HRAs will reimburse Medicare premiums, and employees can use HRA funds to cover medical expenses for spouses and dependents. The HRA is the most flexible of all the medical savings accounts.

There's also another HRA option that's for businesses under 50 full-time employees (including full-time-equivalent employees) during the preceding year. This is the qualified small employer health reimbursement arrangement (QSEHRA), which can be used to reimburse eligible employees for qualified medical expenses. The cost of their premiums can be tax-free when the employer isn't providing medical insurance. The maximum amount available under a QSEHRA for any year cannot exceed specified dollar limits. For 2023, those limits are $5,850 for self-only coverage and $11,800 for family coverage. The discussion below relates to general HRAs and not QSEHRAs.

Who Owns the Account?

HRAs are owned and funded entirely by the employer. This attribute is the biggest difference between HRA and HSA benefits. There are no limits to how much an employer can contribute. Employers can roll over unused funds into the next year or set a maximum rollover limit.

What Expenses Are Covered by an HRA?

An HRA, like a medical FSA, may reimburse only qualified medical expenses. Reimbursements from an HRA may be tax free if they are used for qualified medical expenses. For a detailed list of qualifying expenses, review IRS Publication 502. However, unlike a traditional medical FSA, an HRA may also be able to reimburse health insurance premiums for current employees, retirees and COBRA qualified beneficiaries. Some restrictions may apply.

How To Use an HRA to Your Advantage

For starters, subject to certain conditions and limitations, contributions to an HRA are 100 percent tax-deductible. Because the plans are fully funded by the employer, the company can make a knowledgeable estimate on its maximum expense for health benefits for the year. Additionally, reimbursements are tax-free for employees up to the maximum amount for that coverage year. Finally, HRAs are not a "use it or lose it" account, where any balance expires at the end of each plan year. Employers can choose to carry over a set amount of unused funds into the next year. This feature results in employers typically incurring a financial responsibility that's less than the total value of an employee's HRA.

Which Health Spending Account Is Right for You?

HSA, FSA, or HRA — determining which plan or combination of plans is optimal for your business can be confusing, even after carefully studying and weighing the differences. Variations such as rollover options, employer contributions, funding limits, funding schedules, and reimbursement options affect how you might maximize value for you and your employees. Not-so-obvious conditions like retention issues, employee satisfaction, and whether you're under extreme short-term financial pressures are also worth considering.

You can get help with this important decision. It's prudent to spend time talking with an experienced health benefits specialist who's familiar with the intricacies of each type of health benefits account and can help you determine the best option for your organization. After all, a healthy, thriving workforce can be one of your greatest assets.