What Are Consumer Directed Health Plans?

Consumer Directed Health Plans (CDHPs) offer individuals greater involvement in their medical spending decisions. These plans combine a high-deductible health plan (HDHP) with a tax-advantaged savings account. This structure encourages consumers to be more mindful of healthcare costs and empowers individuals to manage their health expenses proactively.

Understanding CDHP Structures

A Consumer Directed Health Plan is built upon interconnected components. The core of a CDHP is a high-deductible health plan, paired with one or more tax-advantaged savings accounts. These accounts provide financial resources for individuals to cover initial healthcare costs.

High-Deductible Health Plan (HDHP)

An HDHP is a health insurance policy characterized by higher deductibles and out-of-pocket maximums compared to traditional health plans. For 2025, an HDHP must have an annual deductible of at least $1,650 for self-only coverage or $3,300 for family coverage. Annual out-of-pocket expenses, which include deductibles, co-payments, and other amounts but exclude premiums, cannot exceed $8,300 for self-only coverage or $16,600 for family coverage in 2025. This means individuals pay more healthcare costs upfront before their insurance begins to cover expenses.

Health Savings Account (HSA)

An HSA is an individually owned, tax-advantaged savings account designed for qualified medical expenses. Eligibility for an HSA requires coverage under an HDHP and not being enrolled in other disqualifying health coverage, such as Medicare. Contributions can be made by the employee, the employer, or both. Funds remain with the individual even if they change employers or health plans.

Health Reimbursement Arrangement (HRA)

The Health Reimbursement Arrangement (HRA) is another account type that can be part of a CDHP. Unlike an HSA, an HRA is entirely employer-funded and employer-owned. These accounts reimburse employees for qualified medical expenses, as determined by the employer’s plan. Funds in an HRA are typically not portable, meaning they are generally forfeited if an employee leaves the company.

Flexible Spending Account (FSA)

Flexible Spending Accounts (FSAs) also integrate with CDHPs. An FSA is primarily an employee-funded account, though employers may contribute. Contributions are made through pre-tax payroll deductions, and funds can be used for qualified medical expenses. A distinctive feature of most FSAs is the “use-it-or-lose-it” rule, where funds not used by the end of the plan year are generally forfeited. Some plans may offer a limited carryover amount or a grace period.

Operational Mechanics of CDHPs

The payment sequence typically begins with the individual covering costs until the high-deductible health plan’s deductible is met. When a healthcare service is received, the consumer generally pays for the service directly, often drawing from their associated savings account (HSA, HRA, or FSA). This direct payment continues until the individual’s deductible is satisfied. For instance, if an individual incurs medical expenses, they pay the full negotiated cost until their deductible threshold is reached.

Once the HDHP deductible has been met, the health plan begins to cover a portion of the costs, and coinsurance applies. Coinsurance means the individual pays a percentage of the cost for covered services, and the insurance plan pays the remaining percentage. This arrangement continues until the individual reaches their annual out-of-pocket maximum, at which point the HDHP covers 100% of in-network costs for the remainder of the plan year.

Funds from HSAs, HRAs, or FSAs are commonly used to pay for a wide range of qualified medical expenses. These include payments toward the deductible, coinsurance amounts, and other eligible costs not covered by the HDHP. Examples include doctor visits, prescription medications, dental care, vision care, and certain over-the-counter medicines and menstrual care products. The Internal Revenue Service (IRS) defines what constitutes a qualified medical expense.

Many preventive services are covered at 100% by the HDHP, even before the deductible is met. This means individuals can receive services like annual physicals, screenings, and immunizations without any out-of-pocket cost. The IRS periodically expands the list of preventive care benefits that HDHPs can cover on a first-dollar basis.

Tax Treatment of CDHP Accounts

Health Savings Account (HSA)

HSAs are notable for their “triple tax advantage.” Contributions made to an HSA by an individual are tax-deductible, even if the taxpayer does not itemize deductions. If contributions are made by an employer, they are excluded from the employee’s gross income. Any interest or investment earnings on the funds within the HSA grow tax-free. Withdrawals from an HSA are tax-free, provided they are used for qualified medical expenses.

Funds withdrawn for non-qualified expenses before age 65 are subject to income tax and an additional 20% penalty. HSAs are also portable, meaning the account belongs to the individual and can be retained even upon changing jobs or retirement. The annual contribution limits for HSAs are set by the IRS and are adjusted periodically for inflation.

Health Reimbursement Arrangement (HRA)

HRAs offer favorable tax treatment. Since HRAs are entirely employer-funded, employer contributions are tax-free to the employee. Reimbursements received by employees for qualified medical expenses from an HRA are also tax-free. Employees cannot contribute their own funds to an HRA.

Flexible Spending Account (FSA)

FSAs provide tax benefits through pre-tax contributions. Funds contributed to an FSA are made with pre-tax dollars through payroll deductions, which reduces an employee’s taxable income for federal income tax, Social Security tax, and Medicare tax purposes. Withdrawals from an FSA are tax-free when used to pay for qualified medical expenses. The “use-it-or-lose-it” rule means that generally, funds not used by the end of the plan year are forfeited, though IRS regulations allow for a limited carryover amount or a grace period.