What’s the difference between a health savings account (HSA), flexible savings account (FSA) and health reimbursement account (HRA) — and which one is best for your business?
Here’s what you need to know.
HRA vs. HSA vs. FSA: The Basics
Let’s start by considering how each type of account works. We can then compare what they have in common as well as how they differ.
How an HRA Works
With an HRA, medical plan expenses paid by employees are reimbursed by employers. Because of this, despite the name, an HRA technically isn’t an account that holds funds, but rather an agreement between the employer and employee. This is one key difference between HRA and FSA and HSA benefits packages.
For this reason, HRAs are sometimes referred to as health savings arrangements rather than health savings accounts, although both terms are widely used. For simplicity, we’ll call HRAs “accounts” here while comparing them to HRAs and FSAs, but be aware of this key difference.
HRAs come in 3 varieties:
- Original HRAs, which require participants to be enrolled in the employer’s traditional group medical plan
- Qualified small employer HRAs (QSEHRAs), which are available to employers who have fewer than 50 employees and don’t offer group plans
- Individual coverage HRAs (ICHRAs), which employers can offer to employees who have their own individual health-care policies
An HRA is paid for and owned by the employer, who enjoys tax-free contributions and can claim tax deductions on reimbursements. Because HRAs are funded and owned by employers, the employer has considerable say over an HRA’s terms. Employers can decide which types of expenses are covered by HRAs for employees and their qualified dependents, who also must be enrolled in the HRA.
The employer determines how high contribution limits are set. Employers can elect whether to allow unused HRA amounts to roll over from one year to the next. Because the employer owns the account, it doesn’t travel with employees if they go to work somewhere else, which is also true of FSAs but not HSAs.
HRAs don’t require participants to be enrolled in high-deductible health plans (HDHPs), which are plans which have high deductibles and low premiums. This is also true of FSAs, but not HSAs, another point of comparison between the 3 types of accounts. However, an employer may choose to combine an HRA with an HDHP. This results in lower costs when the HDHP’s low premiums are coupled with using the HRA to cover deductibles and other out-of-pocket expenses.
Business owners, including self-employed business owners, generally aren’t eligible for HRAs. However, their spouses who are employees are eligible.
How an HSA Works
In contrast to an HRA, an HSA is funded and owned by the employee, although employers may elect to contribute.
Account ownership conveys a number of advantages to employees. Employees don’t pay federal taxes on HSA contributions, although contributions may be subject to state taxes in some locations, such as California. Withdrawals for qualified medical expenses aren’t subject to tax, although withdrawals for other reasons may be taxed and penalized. Interest earned on accounts isn’t taxed.
Because employees own HSAs, funds roll over from one year to the next. HSAs travel with employees from one job to another. Employees have the option of investing account funds after meeting a minimum threshold.
The Internal Revenue Service (IRS) determines which types of expenses are approved for HSA accounts, and it sets contribution limits. In 2021, limits are set at $3,600 for individuals and $7,200 for families, according to the IRS.
An HSA requires enrollment in an HDHP. This is a point where HSAs differ from HRAs and FSAs.
How an FSA Works
FSAs are distinct from both HRAs and HSAs in that they are funded by employees out of untaxed contributions, but they are owned by the employer. This means that the employee enjoys the tax benefits of the account, but their FSA doesn’t travel with them from one job to the next.
The IRS determines which kinds of expenses an FSA may be used for and sets FSA contribution limits. In 2021, employees may contribute up to $2,750, according to the IRS.
The IRS also sets limits on how much FSA accounts may roll over from one year to the next. For employer plans which allow it, FSA participants can either roll over amounts up to a prescribed limit or take advantage of a grace period that extends into the following year.
The IRS previously announced that in 2021, the rollover limit would be $550 and the grace period would be 2 months and 15 days. However, in light of the coronavirus pandemic, the IRS has granted additional flexibility for FSA plans to use discretion to adjust to employee needs.
What Do These Accounts Have in Common?
Beyond their differences, HRA, HSA and FSA accounts possess some general characteristics in common:
- All 3 types of accounts possess tax advantages
- All cover certain types of approved expenses
- All can be used with an HDHP plan, even though not all require one
- All may allow some amount of rollover
These commonalities make all 3 types of plans viable and attractive options for employers seeking to offer health benefits.
What Is the Difference between HRA and HSA and FSA Accounts?
The most important differences between HRA, HSA and FSA accounts fall into a number of categories:
- Who funds the account
- Who owns the account
- Who gets tax benefits for contributions
- Whether the account travels with the employee from one job to the next
- How much can be contributed to the account
- Who approves expenses
- Who is eligible for the account
- How rollovers are handled
- Whether funds can be invested
These differences underlie HSA vs. FSA vs. HRA account pros and cons.
Both HSA and FSA accounts are funded by employees. Only HRA accounts are funded by employers.
FSA and HRA accounts are both owned by employers. Only HSA accounts are owned by employees.
Tax Benefit Differences
Employees receive the tax benefits for FSA and HSA contributions. Employers receive tax benefits for HRA contributions. HSAs are unique in that they may be subject to state tax laws.
Because only HSA accounts are owned by employees, they are the only type of account which travels with employees from one job to another. FSA and HRA accounts don’t.
Contribution Limit Differences
The IRS sets contribution limits for both FSA and HSA accounts. Employers can only set limits for HRAs.
Expense Approval Differences
The IRS determines which types of expenses are approved for FSA and HSA accounts. Employers approve expenses for HRA accounts.
HSA accounts require participants to be enrolled in HDHP plans. FSA and HRA accounts don’t have this requirement.
Business owners generally aren’t eligible for HRAs.
Rollovers for HSAs are automatic, while those for FSAs are governed by IRS policies and those for HRAs are determined by employer plans.
HSA funds may be invested, while FSA and HRA funds can’t.
Pros and Cons of HRA vs. HSA vs. FSA Plans
Each type of plan has its own advantages and disadvantages.
HRA Account Pros and Cons
From the employer’s perspective, HRAs provide a number of advantages. Employers receive the tax benefits of HRAs. The employer can determine how much to contribute, making it easier to manage costs. Employers have the flexibility to design HRA plans, and can combine them with HDHPs to offer attractive low-premium health care.
From the employee’s perspective, one of the biggest cons of HRAs is that they can’t travel between jobs. However, employers can set up an HRA which allows employees who retire to use funds from the account.
Employers normally aren’t eligible for HRAs, which may be a con for some business owners.
HSA Account Pros and Cons
Employers who elect to contribute to HSA accounts may deduct contributions as business expenses. Because employee HSA contributions aren’t subject to federal tax, they lower employer payroll tax costs. Business owners are eligible to participate in HSAs themselves, which can lower their premiums through participation in the HDHP required by the plan.
Employees appreciate several aspects of HSAs. These include tax savings, a wide range of eligible expenses, rollovers and the ability to carry HSAs between jobs.
The HDHP requirement represents a potential drawback of HSAs. Participants can get stuck with high out-of-pocket costs to cover deductibles.
FSA Account Pros and Cons
As with HSAs, FSA save employers on payroll taxes because employee contributions aren’t taxed. For employees, FSAs offer flexibility with respect to eligible expenses. Some costs not covered by health insurance can be covered by FSAs, such as preventive medical expenses.
FSA funds become available to employees immediately at the beginning of the plan year, which is a pro from the perspective of employees but can be a risk for employers. For example, an employee who encounters a serious medical issue may use all their FSA funds immediately, then quit the next day.
To limit this risk, employers may take steps such as limiting maximum reimbursement amounts, requiring advance payment of contributions or extending waiting periods for eligibility, suggests the Society for Human Resource Management.
For employees, other disadvantages of FSAs include contribution limits, limited rollover and lack of portability between jobs.
Choose the Right Benefit Account for Your Business
Offering competitive health benefits can help you hire top talent and retain high-performing workers. Whether an HRA, HSA or FSA is right for your business depends on factors such as what types of health insurance plans you offer, your budget and your employees’ needs.
Review your health insurance plan and your budget and talk to your workers to help you evaluate which type of account is best suited for your business. A knowledgeable human resources consultant or insurance broker may be able to assist you in making an informed decision.