Editor's Note: This blog post was originally published on October 4, 2018. We have edited content with more up-to-date information.
The notion that healthcare costs are on the rise is ubiquitous. What’s not as obvious is what you as a consumer can do about it. It can see like the options are limited. That’s when opening either a Health Reimbursement Arrangement (HRA) or a Health Savings Account (HSA) can help you.
Both of these accounts can be used to pay for qualified medical expenses. But which account is better for you as an individual, or for your family? It’s going to depend on your specific needs. Let’s start with the basics.
What is an HRA?
A health reimbursement arrangement (HRA) is an employer-funded account from which employees can reimburse their out-of-pocket medical expenses. It can give you flexibility in terms of health insurance since it’s not tied to a particular plan. Sometimes you can even use your HRA to pay for your health insurance premiums, depending on which type of HRA your employer offers.
Your employer can choose to allow your HRA contributions to rollover to the following year. Or allow you access to your balance once you retire or leave the company for another reason.
There are four different types of HRAs:
- Group HRA: This type of HRA is offered as part of an employer-sponsored group health plan. Your employer funds the account and from it you can reimburse yourself for qualified medical expenses.
- Individual Coverage HRA (ICHRA): Employees may use deposits to pay for health insurance premiums as well as qualified medical expenses. This enables employees to purchase their own health plans in the private market.
- Excepted Benefit HRA (EBHRA): You can use deposits for out-of-pocket expenses related to dental, vision, short-term disability, etc.
- Qualified Small Employer HRA (QSEHRA): If your employer has fewer than 50 employees, they might offer this type of HRA. It helps employees buy health insurance plans in the private market and pay for other employer-approved expenses.
The Benefits of an HRA
- You don’t need to buy a specific health insurance plan so you’re free to choose the one that works for you and your family.
- Employers can make unlimited contributions to: Group HRAs, ICHRAs, and EBHRAs. Qualified Small Employer HRAs, do have contribution limits: $5,050 for individuals and $10,250 for families.
- Can be paired with a Flexible Spending Account (FSA).
What is an HSA?
A health savings account (HSA), is a savings account into which you, your employer or anyone else can deposit money tax-free. You can use this money to pay for qualified medical expenses directly by using the provided debit card. You can also reimburse yourself for expenses you paid for using your personal checking or savings accounts or credit card.
To qualify to open and contribute to an HSA you must also enroll in a High Deductible Health Plan (HDHP). If your employer doesn’t offer an HSA or an HDHP, you can buy both in the private marketplace.
In 2021 the annual contribution limits for HSAs are: $3,600 for individuals and $7,200 for families. Any unused contributions roll over to the following plan year and never expire. Meaning you can even take your savings into retirement.
The Benefits of an HSA
- Multiple sources of contributions. You, your employer, relatives or anyone else can contribute to your HSA.
- Tax-free contributions. You won’t pay federal income taxes, (most) state income taxes, or payroll taxes (FICA) on deposits taken directly from your paycheck. If your employer makes contributions, that money is not included in your gross income.
- Tax-deductible contributions. Any contribution made with after-tax dollars can be deducted from your gross income.
- Tax-free distributions. If you use your HSA funds for a qualified medical expense, you will not have to pay taxes - ever.
- Your contributions never expire (even those made by your employer). This allows you to use your HSA as a retirement account.
- You can invest your contributions. Plus, your funds can gain interest tax-free.
- Make changes anytime. You can start an HSA, change the amount you’re contributing or stop contributions altogether at any time during the year. You don’t have to wait for open enrollment.
HRA vs. HSA: Which is Better for Me or My Family?
To decide between an HRA and an HSA, look at your specific circumstances. Each account has different pros and cons, and every family has a different situation. Here are a few things to consider for each type of account:
When You Should Choose an HRA
- You really want to keep your doctor. If using your employer’s health insurance plan won’t allow you to do that, you could choose an HRA over their health insurance plan. Whether it's a specialist or a pediatrician you love, sometimes keeping your doctor is important. If your employer offers an ICHRA or a QSEHRA, you could use it to buy a health insurance plan that allows you to keep your doctor.
- Your employer’s health insurance plan is inadequate for your needs. If your out-of-pocket expenses are too high, you could use a Group HRA to help pay for them. Or you could use an ICHRA or a QSEHRA to buy a health insurance plan that works better for you.
- Your medical expenses don’t change much from year-to-year. Consistent expenses make it easy to plan how you'll use your HRA money.
- A HDHP won’t work for you or your family. One drawback to high deductible health plans is the high deductible. If you’re not sure you can afford it, then an HRA and a more comprehensive health plan might be more suitable for your family.
When You Should Choose an HSA
- You want to lower your monthly health insurance premium. HDHPs typically have lower monthly premiums than other health plans. You can deposit the money you save on your monthly premium into your HSA tax-free. Then use it to help pay for your deductible or other qualified medical expenses.
- You rarely go to the doctor. If you rarely use the medical system outside of preventative care (vaccines count as preventative care), then an HDHP/HSA combo might work for you.
- You can afford to put your own money into a health savings account. Contributing your own money could allow you to save up for larger medical expenses down the road. Remember, HSA contributions never expire!
- You want to use your account to save for retirement. Once you turn 65, your HSA works like a traditional retirement account. You can still use distributions tax-free for medical expenses, but you can also use them for things like groceries. It’s important to note that you will pay income tax on any disbursements you use for non-medical related expenses.
- You want to invest your deposits. Investing is a great way to make passive income and to grow your HSA balance.
- You want flexibility on the timing of your deposits. Maybe you get a year-end bonus and you want to deposit a portion of that into your HSA. Maybe you have major medical expenses for which you want a tax-free way to save. HSAs allow you to change the amount you contribute at any time, so you can deposit money when you have it (or need it), and forgo deposits when you don’t.
To decide between an HRA and an HSA, you’ll have to answer the following questions for your unique situation:
- Why do I want to use one?
- What will put me and/or my family in the best health and financial situation?
- Do the rewards of either account outweigh the potential risks or vice versa?
Both HRAs and HSAs can provide enormous benefits to the consumer. If you have questions about your specific employer-sponsored account, health plan or how these plans might affect your situation, reach out to your Human Resources department.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.