For Your Benefit: HRA, HCFSA and HSA Plans

Healthcare insurance plans have evolved over the last 30 years. Up through the 1980s, the traditional indemnity plan was the most common plan and required a minimum deductible. Once the participant met the deductible, he was responsible for a percentage of the remaining cost after coverage was provided by the insurer. Then in the 1990s the Health Maintenance Organizations (HMO) became popular, which in some cases offered 100 percent coverage as long as the participant used a particular facility or specific network of providers – with no coverage outside the network. A higher-end alternative to this plan called the Preferred Provider Organization (PPO) also came into being during this time. The PPO generally charged a higher premium than an HMO, but offered some level of coverage for any provider and greater coverage when the member selected a preferred network provider.

Because of the way these insurance models evolved, people were not aware of how much money was spent on health care because they never received the provider bills. These bills were paid by the insurance companies. As there was no or minimal financial consequence, people increased their visits to doctors and demanded more tests and services. Additionally, doctors were motivated to increase the number of patient visits and related diagnostic tests as they were paid more when patients used their services more. The cost of healthcare has escalated tremendously over the years, forcing employers and their workers both to contribute more and more to this important employee benefit.

Employers, insurance companies, providers, participants and legislators have all rallied to find ways to contain the rising cost of healthcare. One solution is to create more transparency so that consumers understand the cost of the medical care they receive. To this end, three "H" programs have become popular: The HRA, HSA, and HCFSA.

These programs work in concert with regular insurance policies, enabling participants to pay for their share of medical expenses with subsidized and pre-tax dollars. With these plans, a worker and/or his employer may contribute money to an individual account reserved in the participant's name to pay for medical expenses. Typically, the money contributed is not taxed. Therefore, as long as the participant uses the proceeds from the account to pay for qualifying medical expenses, he never has to pay taxes on that income.

However, the difficult part of understanding these plans is differentiating them, and they are commonly referred to by their acronyms. The following is a primer to help you understand the nuances of how each of these accounts works and when each may be appropriate in specific situations.

HRA: Heath Reimbursement Account
Only one of these plans, the Heath Reimbursement Account (HRA), must be entirely funded by employer contributions, and it is offered separately from a health insurance plan. Because it does not allow the participant to contribute to it, there is no salary deferral and therefore no income tax advantage for the participant. Instead, the employer is allowed to deduct any HRA contributions it makes on behalf of participants from its corporate tax return. The employer also decides how much money to put in worker HRAs each year. There is no annual limit except in the case of a stand-alone HRA (one that is not integrated with another type of coverage, such as a retiree-only HRA).

With an HRA, an employer funds an individual reimbursement account for each participating worker and defines what those funds can be used for – such as copays, coinsurance, deductibles, and/or services not fully covered by the insurance plan. It also is up to the plan sponsor to decide whether the funds will roll over from year to year. However, HRA accounts are not portable, meaning the worker will no longer have access to those funds once he separates from the company.

HSA: Health Savings Account
A Health Savings Account (HSA) may be offered only in concert with a high deductible health care plan (HDHCP). In 2015, a "high deductible" is defined as at least $1,300 for individual coverage or $2,600 for a family plan. Originally available to self-employed people, many employers now offer HSAs. In fact, about 45 percent of all U.S. companies now offer an HSA-eligible HDHCP.

In 2015, the most that can be contributed to an HSA in one year is $3,350 for an individual plan or $6,650 for a family plan. Participants age 55 and older can add up to $1,000 more a year in catch-up contributions. Both the worker and the employer are allowed to contribute money to the HSA. The money the worker contributes is pretax. The money distributed to pay for qualifying medical expenses isn't taxed either. However, withdrawals used for nonqualified medical expenses are subject to both income taxes and a 20 percent penalty. After age 65 or Medicare eligibility, account owners may withdraw funds for any reason without being subject to the 20 percent penalty, but money used for nonmedical expenses will be subject to income taxes.

There are three distinct advantages with an HSA.

1. The entire balance rolls over every year; unused amounts are not forfeited
2. The account is portable; if the worker leaves the employer, it can go with him
3. Similar to an individual retirement account (IRA), HSA contributions can be invested
     in a variety of investment vehicles and interest is earned tax-free

HCFSA: Health Care Flexible Spending Arrangement
A Flexible Spending Arrangement (FSA) is a tax-advantaged account that allows the participant to defer some of his pretax salary to pay for qualified expenses. The healthcare version of a flexible spending account is known as an HCFSA, differentiating it from a similar plan designed to pay for dependent care expenses.

The tricky part for participants is figuring out at enrollment how much to contribute regularly from each paycheck. That's because if, by the end of the year, he hasn't fully used up the account balance to reimburse medical expenses incurred throughout the year, he may lose some of the money. The IRS allows participants to carry over up to $500 of unused funds into the next plan year, although employers may set a lesser amount.

The FSA requires enrollees to carefully consider their ongoing health care expenses such as regular prescription drugs, copays for doctor, dentist office or vision care visits, contact lenses, orthodontia payments, etc. It's best for employees to save through this plan for known expenses rather than "what ifs," because they may lose income if those "what ifs" never happen. However, some plans may offer a grace period, which begins on the first day immediately following the last day of the plan year and generally ends two months and 15 days later. During the grace period, participants may continue to incur eligible FSA expenses and use the funds remaining in their prior year account balance to cover them. Note, however, that an employer may offer either the $500 carry over feature or the grace period with an HCFSA plan, but not both.

Unlike an HRA, the FSA is funded only by the participant and salary deferrals are not taxed. As long as a worker uses this money to reimburse qualifying expenses, the money contributed to the account is never taxed. In 2015, contributions are limited to $2,550.

Who Benefits From Each Plan?
There are three variables that should be considered to help determine which type of plan to offer. First, consider the budget. Do you want the employer to make generous contributions to create a highly attractive benefit, or would you prefer a more modest investment and to use these monies elsewhere in other areas such as payroll?

Second, consider if you want to create an incentive for members to stay with the employer, or if you're fine with allowing them to take their savings account with them when they leave. And finally, consider how much you wish to be involved or pay a third party to administer the employee accounts.

The HRA offers a richer health care benefit with a predictable budget, as it is fully funded and enables the employer to decide in advance how much each employee will receive. Because it is not portable, it also gives members an added incentive to remain with the employer. Members can access HRA funds regardless of the type of health insurance plan they have.

An HSA can be funded by the participant and employer (optional). It offers the maximum flexibility to workers because contributions are tax-free, they can take the account with them if they leave the employer, and they can invest its funds for long-term growth. It's also an easy plan to maintain because individual accounts are managed by participants. However, the HSA has annual contribution limits and can accept contributions only when used with an eligible high-deductible health care plan – even after the worker leaves the employer. Distributions for qualified medical expenses are allowed even if the participant is no longer covered by an HDHCP.

The HCFSA is a basic plan that enables workers to use tax-free income to pay for foreseeable health care expenses. There are annual contribution limits, it is not portable, and workers have a limited timeframe in which to use or forfeit the money in the account. While it requires administration by the employer (or a third party), many different types of employer-sponsored health insurance plans can be paired with a flexible spending account.

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