HRA vs. HSA: Which Is Better for Your Finances?

Health expenses are a significant part of many personal budgets, making understanding various healthcare savings and reimbursement options important. Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs) are two distinct types of health benefit accounts designed to help individuals manage these costs. While both offer tax advantages and support healthcare spending, they operate differently, with unique rules governing their funding, ownership, and usage. This article explores the characteristics of HRAs and HSAs to clarify their roles in personal finance.

Understanding Health Reimbursement Arrangements

A Health Reimbursement Arrangement (HRA) is an employer-funded health benefit plan that reimburses employees for qualified medical expenses and, in some cases, insurance premiums. These plans are owned and controlled by the employer, meaning the funds generally remain with the employer if an employee leaves the company. HRAs are not pre-funded accounts; instead, they operate on a reimbursement basis where employees pay for qualified expenses upfront and then submit claims.

Employers have discretion in setting up HRA plans, including defining the annual reimbursement limits and the specific expenses eligible for reimbursement. Reimbursements received by employees through an HRA are tax-free. For employers, contributions and reimbursements made through an HRA are tax-deductible business expenses.

There are several types of HRAs. A Qualified Small Employer HRA (QSEHRA) is for small businesses with fewer than 50 full-time employees that do not offer a group health insurance plan, allowing them to reimburse employees for individual health insurance premiums and other qualified medical expenses on a tax-free basis. An Individual Coverage HRA (ICHRA) can be offered by employers of any size and allows them to reimburse employees for individual health insurance premiums and qualified medical expenses, with no annual contribution limits. An Excepted Benefit HRA (EBHRA) is offered in conjunction with a traditional group health insurance plan and can reimburse for dental, vision, and other medical expenses not covered by the primary plan, with an annual limit of $2,100 for plan years beginning in 2024.

Understanding Health Savings Accounts

A Health Savings Account (HSA) is a tax-advantaged savings account specifically designed for healthcare expenses. A key requirement for HSA eligibility is enrollment in a High Deductible Health Plan (HDHP). An HDHP is a health plan with a higher annual deductible than typical health plans and a maximum limit on out-of-pocket medical expenses.

HSAs are employee-owned and fully portable, meaning the funds belong to the individual and remain with them even if they change jobs or retire. Contributions to an HSA offer a triple tax advantage: contributions are tax-deductible, the funds grow tax-free, and withdrawals for qualified medical expenses are also tax-free. Contributions can be made by the employee, an employer, or other third parties. For 2024, the annual contribution limit is $4,150 for self-only coverage and $8,300 for family coverage. Individuals aged 55 or older can contribute an additional $1,000 annually as a catch-up contribution.

HSA funds can be invested once a certain balance is reached, allowing for tax-free growth over time. Funds used for non-qualified expenses before age 65 are subject to income tax and a 20% penalty. After age 65, withdrawals for non-qualified expenses are taxed as regular income but are not subject to the 20% penalty. Qualified medical expenses, as defined by IRS Publication 502, include a wide range of services and products, from deductibles and co-payments to prescription drugs and vision care.

Comparing HRAs and HSAs

Health Reimbursement Arrangements and Health Savings Accounts both facilitate the management of healthcare costs, yet they differ significantly in their structure and benefits. A primary distinction lies in ownership; HRAs are employer-owned, and the funds remain with the employer if an employee leaves their job, limiting portability. In contrast, HSAs are individually owned, providing full portability of funds, which belong to the employee regardless of employment changes.

Funding mechanisms also vary; HRAs are exclusively employer-funded, meaning employees cannot contribute their own money to these accounts. HSAs, however, allow contributions from the employee, the employer, or even third parties.

Regarding rollover provisions, HRA plans may or may not allow unused funds to roll over from year to year, depending on the employer’s specific plan design. HSA funds always roll over year to year, accumulating over time without a “use-it-or-lose-it” rule.

A key difference is the health plan requirement. Eligibility for an HSA is strictly tied to enrollment in a High Deductible Health Plan (HDHP). HRAs, depending on their type, can be offered with various health plans, including traditional group health insurance or individual coverage. HSAs offer investment potential, allowing account holders to grow their funds through various investment options, whereas HRAs do not offer this feature.

Both accounts provide tax advantages, though the nature of these advantages differs. HRA reimbursements are tax-free for employees, and employer contributions are tax-deductible for the business. HSAs offer a triple tax advantage: tax-deductible contributions, tax-free growth on investments, and tax-free withdrawals for qualified medical expenses.

Factors to Consider When Choosing

Selecting between a Health Reimbursement Arrangement (HRA) and a Health Savings Account (HSA) depends on individual circumstances and financial goals. There is no universally “better” option; the most suitable choice aligns with one’s current health plan, anticipated medical needs, and long-term financial strategy.

A primary consideration is the type of health plan an individual is enrolled in. An HSA requires enrollment in a High Deductible Health Plan (HDHP) to be eligible for contributions. If an individual does not have an HDHP, an HSA is not an option for them. HRAs can be offered with various health plans, including traditional group plans or individual coverage, making them accessible to a wider range of individuals.

Employer offerings also play a role, as HRAs are employer-funded and established, so employees can only participate if their employer provides one. While HSAs can be opened independently, employer contributions to an HSA can boost its value, making employer-sponsored HSAs more attractive. The level of anticipated healthcare needs should also guide the decision. Individuals with high or predictable medical expenses might find an HRA beneficial for immediate reimbursement of out-of-pocket costs, especially if the employer contributes generously. Conversely, those with low current medical expenses might prefer an HSA to save and invest funds for future health needs.

Financial goals also influence the choice. If the primary goal is to cover immediate healthcare costs with pre-tax dollars, either account can serve this purpose. However, if the aim is long-term savings and investment for future medical expenses, particularly in retirement, the investment potential and portability of an HSA offer an advantage. The ability to invest HSA funds can lead to growth over decades, providing a resource for healthcare in later life.

Consideration of control and portability is also important. HSAs offer complete individual ownership and portability, allowing funds to be carried over year after year and moved between employers. HRAs, being employer-owned, lack this portability, and unused funds may not transfer with the employee upon job changes. The different tax implications should be evaluated in the context of one’s overall financial and tax planning. While both offer tax benefits, the triple tax advantage of an HSA can provide long-term savings opportunities compared to the tax-free reimbursements of an HRA. Finally, an individual’s capacity to contribute consistently to an HSA should be assessed, as maximizing contributions is important to leveraging its long-term benefits.