Do you know the difference between an HSA and a health care FSA? How do you know if one is a better option than the other for you and your employees?
Each is very different in intent and scope, and choosing between them can be a difficult decision. Start by educating yourself on the basics.
HSA is the acronym for health savings account; FSA is the acronym for flexible spending account. An easy, basic way to distinguish what each account is intended for is by focusing on what the letter “S” represents in each: savings and spending. And that’s also the clue to how each operates.
What you need to know about HSAs
An HSA is a type of individual savings account typically established at a bank, similar to a college or retirement fund. Funds that are not used roll over from year to year and help the account holder save for future medical expenses.
Contributions made by the account holder are generally tax-free, but withdrawals are only tax-free when used to pay for eligible medical expenses.
Although there is an annual contribution cap, there is no cap on how much money can ultimately be accumulated in the plan. The annual contribution cap, adjusted for inflation, is published by the IRS each year. It’s a good idea to check it for periodic updates.
Withdrawals for non-eligible expenses are allowed, but taxed and subject to a 20-percent penalty, until the employee reaches age 65. At that point, employees can withdraw funds for any reason without penalty. Income tax is still owed on funds taken out of the account for non-eligible expenses.
Once an HSA account balance reaches a certain amount (typically $2,000), the funds can be invested (if the account holder chooses) in stocks, mutual funds and other instruments, making it a true long-term, tax-free investment for retirement. An HSA can provide a savings avenue for people who don’t think they need or have the ability to save.
To establish and make contributions to an HSA, an individual:
- must be enrolled in a high-deductible health plan;
- cannot be covered under a second health care plan; and
- must not be eligible for Medicare or claimed as a dependent on someone else’s tax return.
Unlike health care FSAs, HSAs are not employer-sponsored plans, and the HSA account and balance belong to the account holder at all times. However, employers can encourage their employees to participate in HSAs by:
- offering a qualifying high-deductible health plan, which provides employees with the underlying medical coverage needed for HSA eligibility;
- establishing an HSA program, so employees can make pretax contributions through payroll deduction; and
- making employer contributions to the employee’s HSA.
What you need to know about health care FSAs
A health care FSA is a very different animal.
FSAs are employer-sponsored plans, and access to these plans depends on employment status.
Like an HSA, FSAs help employees set aside pre-tax funds throughout the year to help pay for eligible medical expenses. But unlike HSAs, employees don’t have to be enrolled in a health care plan to contribute.
The biggest advantage FSAs have over HSAs is the employee’s ability to be reimbursed up to the full annual elected amount, regardless of how much the employee has contributed.
For example, an employee may elect to contribute an annual amount of $2,000. The full $2,000 is available at any time during the year, regardless of how much money the employee has contributed.
As with an HSA, the amount an employee can contribute annually is capped by the Internal Revenue Service. The FSA cap for 2019 is $2,700. Employers may choose to allow a lower cap, but they cannot increase it.
There is one significant downside for employees, however. An FSA is typically a use-it-or-lose-it fund. Any money not spent during the calendar year is forfeited, which means unused savings are lost.
Plans can be designed to allow employees to roll over up to $500 of unused funds, but funds in excess of the rollover amount are still forfeited.
So, it takes careful prediction of expected expenses for an employee to decide how much they should contribute yearly to avoid losing money.
The good news for employers is that forfeited funds can be used to help with the cost of administering the plan.
The downside for employers is that you have to reimburse eligible FSA expenses, whether the money has been contributed to the plan or not at the time of the reimbursement.
HSA or health care FSA: Deciding between the two
There are a number of factors to consider when deciding whether to offer your employees an HSA program, a health care FSA or a choice between the two.
- When considering HSAs: Is your workforce primarily young, healthy and willing to assume more of their health care expenses? Does your organization want or need employees to bear more of the burden for health care costs? If so, offering an high-deductible health plan in conjunction with an HSA program may be an attractive solution.
- When considering FSAs: Do many of your employees have lower salaries, and families with frequent, predictable health care expenses? This population may not be as comfortable with the significant out-of-pocket expenses required for HDHP coverage and may not appreciate the ability to access the full FSA amount at any time during the year.
- Retirement savings option: Are your employees in the habit of saving for their retirement? Do you offer a 401(k) plan, or do you expect employees to assume responsibility for their own retirement savings? HSAs may help fill that gap for employees who don’t have other retirement savings options.
- Employee preferences: Are your employees asking for access to an FSA or HSA? Are you listening to them when they express preferences about their health care needs, so they can get the most from their benefits?
- Offering access to both plans: Would offering access to both be beneficial? There is no rule against offering employees a choice between an HSA program and an FSA plan. And, as is the case in many work environments today, doing so may prove to be a good way to provide benefits across a diverse employee base.
For you – the employer – the main benefit of offering either an FSA or an HSA program is a reduction in Social Security and Medicare taxes on pretax employee contributions to those accounts, which reduces your overall payroll taxes.
And the costs of running either, whether in-house or outsourced, is tax-deductible as a business expense.
Any negatives to offering either?
Both options require specific documentation and ongoing maintenance and administration. However, FSAs are also considered group health plans, which means they are subject to ERISA, HIPAA and COBRA.
In addition, employers can face a shortfall in FSA contributions if employees access their full amount and terminate employment before making all required contributions.
Before making a decision, make sure you weigh all the options available, along with your employees’ preferences. That way, you’re more likely to make the right decision for your employees and your organization.
Providing your employees with robust benefits is key to helping them stay healthy, productive and engaged, but it can be a complex endeavor. Get more of the answers you need by downloading The Insperity guide to employee benefits.