Let’s face it, healthcare has become a major expense for everyone in this country. To help offset a portion of this costly burden for employees, employers typically offer two very popular tax-advantaged savings accounts: HSAs and HRAs. But what’s the difference between these two healthcare savings plans and which is better for your employees and your company?
Defining HSAs and HRAs
An HSA, or health savings account, is a savings account specifically linked to a qualified high deductible health plan (HDHP). It’s meant to help offset the higher out-of-pocket expenses that potentially come with plans of this design.
Per IRS 2019 guidelines, individuals enrolled in HDHPs can contribute up to $3,500 to their HSAs, while the limit increases to $7,000 for family plans. One of the easiest ways to fund an HSA (but not the only way) is through pre-tax payroll deductions, which can help lower employees’ tax obligations. In addition to employee contributions, employers can also contribute to their employees’ HSAs, but the annual contribution cap remains the same, regardless of how many sources contribute.
An HRA, on the other hand, is a health reimbursement account, an unfunded notional account owned by the employer that only the employer can fund. It also is designed to help employees pay for qualified medical expenses. Unlike an HSA, there are no limits to the amount an employer can contribute to an HRA, though unspent funds, which may accumulate over time at an employer’s discretion, are forfeited upon leaving the company.
HRAs function differently than HSAs because funds do not accumulate (unless otherwise specified by the employer). In fact, an HRA is merely an IOU — employers don’t have any financial liability until an employee incurs an eligible claim. And if the funds are not completely claimed by the end of the plan year, the employer gets to keep the unspent balance.
The Advantages of an HSA
At first sight, some of the benefits HSAs can provide for enrollees may appear to be disadvantages for employers, making the HRA the obvious choice. However, the HSA can be an excellent option for both parties:
Lower Premiums: The high deductible health plans that accompany the HSA mean premiums are typically lower for both for the business and the policyholder.
Roll Over of Unspent Balances: Because HSAs never “expire,” they eventually become a retirement plan. If a small business has to choose between health insurance and retirement matching (or profit sharing), HSAs are a great compromise between the two.
Compound Growth Opportunities: Most HSAs balances can be invested in mutual funds and other investment vehicles which, through compound growth opportunities, can increase the funds employees have available to cover necessary medical expenses. Employees are typically allowed to guide these investments once HSA account balances reach a certain threshold.
More Engaged Consumers: HSA enrollees tend to become more engaged in their healthcare decisions because they’re managing an account which isn’t “use it or lose it”, which incentivizes them to become more educated consumers of healthcare. If given the choice between a brand name medication or a generic, they may be more likely to try the cheaper generic when they’re paying the full price, rather than a copay. They’re also empowered to do more pricing research ahead of planned procedures or bloodwork.
Easier/Cheaper to Administer: HSA administrative fees are lower than those of HRAs because administration is simpler (there’s no claims substantiation or accountholder-directed distributions) and plan documents aren’t required.
The Advantages of an HRA
Despite a long list of features which make HSAs very attractive, HRAs also have several great things going for them;
Unlimited Contributions: While HSAs restrict contribution amounts to $3,500 for single employees and $7,000 for employees with families, the IRS does not impose a limit for HRA contributions
Reimbursement Options: An HRA can have virtually an infinite number of plan design options, though two of the most popular are known as “first dollar” and “last dollar” funding arrangements. If set-up as a first dollar account, employers reimburse eligible expenses from the first dollar up the declared HRA limit. Under a last-dollar arrangement, the employer pays eligible expenses after an employee pays an initial amount set at the employer’s discretion
Recouping of Contributions: With an HSA, employees can roll over unused funds (no matter who contributed them) from year-to-year in perpetuity, as there’s no “expiration date” on these accounts. However, HRA funds are truly "use it or lose it," meaning that funds can only be used when genuine medical expenses are incurred, and if an employee leaves the company, those funds are no longer available to them. In addition, any unspent balance expires at the end of each plan year.
Encouragement of Health Spending: Some argue that the “use it or lose it” aspect of an HRA encourages employees to seek medical care they otherwise might avoid because a) they don’t have the funds to pay for it, or b) they have funds through an HSA but they’d rather have those unspent balances roll over into retirement savings. On the flip side, some argue that HRA participants spent these “use it or lose it” funds more frivolously — and never become as engaged in price shopping as one would like.
Less Eligibility Restrictions: HSAs carry a number of other restrictions which HRAs do not. For example, HSA participants cannot be covered by any other non-HSA qualified health plan, such as one a spouse might be offered through another employer. They also cannot be enrolled in Medicare, cannot be claimed as a dependent on someone else’s taxes, and may not have a (standard) flexible spending account while actively contributing to an HSA.
Making the Choice: HSA vs. HRA
Offering and contributing to an HSA or HRA for your employees is a great way to let them know you care while at the same time turning them into more educated consumers of healthcare. In doing so, you’ll help offset their out-of-pocket healthcare expenses while they hopefully come to appreciate the true cost of healthcare.
If you want to learn more about how HSAs and HRAs can benefit your company or get more information about setting up a plan for your employees, contact one of our KBI consultants today at (408) 366-8880. We’d love to talk with you!