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: HRAs and HSAs. But what’s the difference between these two healthcare savings plans, what are the legal distinctions, and which is better for your employees and your company?
Making an informed decision about these tax-advantaged reimbursement plans can help you maximize the benefits for both your employees and your company.
(For a side-by-side comparison of these plans, including comparisons to FSAs and QSEHRA tax-advantaged accounts, click here to download our four page guide.)
Defining HRAs and HSAs
Not to be confused with a flexible spending account (FSA), 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 guidelines for 2019, 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. These savings can help your workforce pay for eligible medical expenses, including both voluntary and necessary medical, dental, and vision care.
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. Contributions made by an employer through a section 125 plan are not counted as part of employee wages and aren’t subject to taxation.
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 Benefits of Offering an HSA or HRA
HRAs and HSAs share several key benefits:
Turn-Key Participation: Providing employees with any type of turnkey tax-advantaged reimbursement mechanism eliminates hurdles and makes it easier to participate. While employees do have to take a few steps to set-up these accounts, it’s relatively painless and most employers take great pains to walk employees through the set-up and reimbursement process, the latter of which is sometimes as effortless as a debit card.
Employer Contributions: Both accounts allow employers to make contributions. This act demonstrates you’re invested in the health and welfare of your employees and their covered dependents — and that you realize it’s sometimes difficult to cover out-of-pocket expenses.
Promotes Healthcare: By providing tax-advantaged spending power, both accounts should allow employees to take better care of themselves, which in turn should lead to prevention or earlier detection of more serious health issues which otherwise could prove costly to both employee and employer. This leads to happier, healthier employees who are less likely to need long stretches off work for medical care.
Promotes Consumerism: HRAs and HSAs also encourage employees to pay more attention to medical spending, making wise choices as they attempt to stretch their funds out over the course of the plan year. Some argue that HSAs may discourage spending, because of their roll over and portability features, while HRAs encourage spending, because of their “use it or lose it” framework. Either way, paying for medical care in this manner can lead to employees becoming more aware of actual medical costs and empower them to be better prepared for the financial challenges they may face when seeking medical care.
Plan Level Distinctions: As a pre-tax benefit, both accounts allow employers to make plan level distinctions in terms of the amount to contribute to each account, so long as these are based on bonafide business classifications. Note that these differences are allowed as long as they do not discriminate in favor of highly compensated individuals (HCIs), in accordance with non-discrimination testing requirements. They must also be based on class, not just for one participant, and must typically be pre-approved by the carriers. Examples of other unjustified classifications include those based on protected classes, such as age, gender, and race.
Examples of bonafide employment classifications include: full-time versus part-time status, current versus former employee status, different geographic location, occupation type, date of hire, and length of service.
HRA vs. HSA
As discussed, HRAs and HSAs offer similar benefits, especially with regard to employee wellness, engagement, and satisfaction, but they have several key differences. Understanding those differences is one of the best ways to determine which one is the right choice for your company.
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. It’s important to make sure your employees know about this valuable benefit, unique to this type of savings account. If they’ve had FSAs in the past, they may not realize that the funds roll over each year.
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. Some labs are less expensive than others, as is the case with some surgery centers.
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. Employers usually have the option to absorb the fees, and most do, though some administrators allow employers to shift that responsibility to employee participants. (An HRA administrator typically charges an annual fee to draft and review plan docs, set-up the HRA in the admin’s claims system, process claims, and submit reimbursements.)
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. Note that this should not be confused with the new Qualified Small Employer HRAs (QSEHRAs), which permit employers to contribute up to $5,050 for single employees and as much as $10,250 for employees with families. You can read more about QSEHRAs here.
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. Setting up an HRA that reimburses in a last dollar manner such as this typically cost the employer half the total outlay of an HRA that reimburses the first half.
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 (though the employer can chose to allow some portion to roll over at their discretion). Because of this, employers typically incur a financial responsibility that is only between 20 to 40 percent of the total value of an employee’s HRA.
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 flipside, 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.
Available With More Plans: HSAs are only available in conjunction with high deductible health plans while HRAs can be used with far more plan types. That said, since the passage of the Affordable Care Act (ACA), HRAs can only be offered if they are considered to be integrated with a group health plan, and stand-alone HRAs are not permitted unless they’re limited to excepted benefits or fall under an exemption to the ACA.
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.
Payment of Premiums: IRS rules allow use of HRA funds for health insurance premiums, long-term care coverage, and qualified medical expenses not covered under another health plan, though it is up to individual employers to decide whether their employees can use the funds for these purposes. On the flipside, prior to age 65, HSA funds cannot be used for most individual premium reimbursement, except under limited circumstances which include COBRA continuation coverage, health coverage purchased while an individual is receiving unemployment compensation, and qualified long-term care insurance. When age 65 or older, HSA funds can be used to pay premiums for any health insurance, except Medicare supplemental policies (also known as Medigap).
Which One Is Better?
If you’re not sure whether HRAs or HSAs would be better for your workforce, don’t worry — you don’t always have to pick one. You can actually offer your employees both an HRA and an HSA if you offer both a qualified HDHP and a more traditional health insurance plan with an integrated HRA. You can even offer a healthcare FSA and something called a limited purpose FSA (LPFSA) as part of your benefits portfolio, but that’s a subject for a different blog post.
One word of caution: offering so many options may introduce confusion, and something behavioral psychologists call the “paradox of choice”. In situations like this, we strongly advise you to go great lengths to thoroughly education your workforce on their options. Detailed benefit guides, videos offering explanations, and open enrollment meetings are a must, as are other communication guidelines in your brokers’ communications toolkit.
In other instances, you may find that choosing a single method for offsetting employee healthcare expenses is best, especially if you are striving to achieve a particular benefits strategy. Accordingly, there are several things you should consider when deciding between an HSA and HRA for your employees.
For example, if you’re planning to contribute to your employees’ HSA or HRA, what are you hoping to accomplish with this, rather than, for instance, contributing more to the cost of premium? Are you trying to incentivize participants to become more price conscious and better educated consumers of healthcare? Are you trying to maximize the dollars which remain with your company should employees not seek or need the anticipated level of healthcare forecasted? Are you trying to entice employees to stay with your firm or make yourself more attractive to new hire candidates?
Next, are you considering HSA and HRA contributions but making them contingent on participatory or outcome-based wellness activities? If so, what are you hoping to achieve in doing so? If you tie a portion of the contribution to participating in a biometrics screening, you could obtain invaluable biometric data which would help you (with the assistance of your broker, wellness vendor, or insurance carrier) institute some population health programs (and even some individual case management, provided that the information is handled by your health partners in strict compliance with HIPAA regulations.) If you tie a portion of the contribution to an annual flu shot or annual physical, you could help prevent sickness or aid in the early detection of a condition which could lead to something far more serious and costly.
These are just a few of the many issues to ponder when choosing between these two savings account options. Your employee benefits broker can (and should) walk you through several other considerations.
Making the Choice: HRA vs. HSA
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 done right, this should help to increase the value your employees place on healthcare as a critical component of your employee benefits package.
If you want to learn more about how HRAs and HSAs can benefit your company, read more about HRAs and HSAs, or get more information about setting up a plan for your employees, contact us. We’d love to talk with you!