What is a Health Savings Account?
A Health Savings Account (HSA) is a tax-advantaged savings account, which means that it is a savings account where money that’s deposited can be used to pay for medical expenses without the employee being taxed. An HSA can be opened by an individual or offered by an employer in conjunction with a high deductible health plan (HDHP), but are always owned by the beneficiary. Both individuals and employers may contribute to the HSA up to the annual deposit limit.
If an individual owns an HSA, as taxpayers they will receive a 100% income tax deduction on annual contributions, they can withdraw HSA funds tax-free to reimburse themselves for qualified medical expenses, and they can also defer taking reimbursements indefinitely without penalties.
Health Savings Account offer a unique health benefit to individuals with triple tax advantages:
- Tax-deductible contributions
- Tax-free accumulation of interest and dividends
- Tax-free distributions for qualified medical expenses
What are the pros of an HSA?
1. Tax saving
The contributions that individuals make towards an HSA are tax deductible. Likewise, contributions made by the employer are excluded from the employee’s gross income.
2. Full Rollover
All contributions made by the individual remain in the HSA indefinitely until they use them. HSA holders don’t have to deal with a vesting schedule or any penalty for not spending the money, and the savings roll over year to year.
3. No tax on qualified withdrawals
The withdrawals used to pay qualified medical expenses for the individual, their spouse, or their dependants are never taxed. Any interest earned on the account accumulates over the years with tax deferred.
4. Portability
The HSA is portable and belongs solely to the individual who holds the account. Even if they change employers or leave the workforce, the HSA stays under the ownership of that individual.
What are the cons of an HSA?
1. Contribution limits
HSAs have an upper limit to annual contributions which limit how much one can contribute each year.
2. Eligibility requirements
In order to be eligible to contribute to an HSA, the concerned individual is required to be enrolled in an HSA-Qualified High-Deductible Health Plan.
3. Complicated rules
With an HSA, the individual is the plan administrator. As such, the rules and record keeping of the HSAs often tend to be complicated and cumbersome for most.
What are HRAs compared to HSAs?
Health Savings Accounts are commonly confused with Health Reimbursements Arrangements (HRAs) because of their ability to be used towards out-of-pocket expenses. However there are a few key differences that employers should be aware of.
HSAs are an account that employers and employees can regularly contribute towards. With it, employees can gather savings and eventually spend it on health related expense or cash it in during retirement. They are a tax-exempt method for employers to support their employees’ health benefit needs, but can only be offered in conjunction with an HDHP. Employers contribute a fixed cost towards an HSA and employees are able to collect these when they leave.
HRAs are a tax-free arrangement. It is such an arrangement where employers reimburse employees for health-related expenses and only pay for it when their employees use it. Unlike HSAs, HRAs receive no contribution from the employee, and employers only incur the expense when employees incur them. Unused HRA allowance remains with the employer if an employee leaves the company.
HRAs enable employees to shop for individual health insurance that fits their needs best, rather than accept or deny the group health plan chosen by their employer. This advantage gives employees more control over their healthcare than any other type of health benefit. An addition benefit to employers is the ability to set a fixed allowance that cannot be exceeded.
Can employees have both HSA and HRA?
The Health Savings Account and Health Reimbursement Arrangements can be offered simultaneously. In order to be eligible, the individual must be covered by a HDHP. For this reason, many employers who wish to offer HSA benefits either let employees shop for their own policy and opt into the HSA benefit, or they offer an HDHP, pair it with a group coverage HRA (GCHRA) and offer an HSA to help employees cover out of pocket medical expenses.
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