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If you've had a medical need, you know how important health insurance coverage can be. But health insurance doesn't usually come cheap—whether you get it through your employer, private insurance or the Affordable Care Act's Health Insurance Marketplace. According to nonpartisan policy research group KFF, average annual premiums for employer-sponsored family coverage hit $20,576 in 2019; with the average worker paying $6,015 of that total. If you're self-employed, it's all on you.
Health savings accounts (HSAs) and health reimbursement arrangements (HRAs) are health care savings plans that can save you money on medical expenses. Using them can be complicated, however, so let's take a closer look to see if an HSA or HRA might be right for you.
What Is an HSA?
An HSA is a way to save for future medical expenses. You make pretax contributions to the HSA and withdraw the funds to cover qualified medical expenses, including deductibles, copayments and coinsurance.
Some employers offer HSAs, and you can also set one up on your own. To qualify for an HSA, however, you must have a high deductible health plan (HDHP) and no other health insurance. (There are exceptions for dental, vision and other specialized types of health insurance.) A deductible is the amount you must pay out of pocket before your health insurance kicks in for covered services. As of 2020, the IRS defines an HDHP as one with a deductible of $1,400 or more for an individual or $2,800 or more for a family. With the average individual deductible in 2019 at $1,655, according to KFF, plenty of Americans qualify.
The money in the HSA belongs to you, even if you leave your job, retire or change health insurance. If you ditch your HDHP, you can't contribute to the HSA anymore, but you can still take money out of it.
If your employer doesn't offer an HSA, you can open one on your own with any financial institution that's authorized to be a trustee for HSA accounts. This can include banks, credit unions or companies that manage individual retirement accounts (IRAs). You can ask your health insurance provider if they work with any organizations that manage HSAs, or use a comparison service such as HSA Search to find and compare HSA providers
What Is an HRA?
A health reimbursement arrangement (HRA, sometimes called a health reimbursement account) is an account that employers can set up to help employees pay for qualified medical expenses. Your employer funds your account at the beginning of the year up to a set amount, which you can then draw against to be reimbursed for qualified medical expenses.
The HRA belongs to your employer, and only the employer can contribute to it. That means if you leave your job, you lose access to the funds. HRA contributions are not deducted from your paycheck.
As of January 1, 2020, employers have the option to provide an HRA in place of traditional health insurance. Unlike an HSA, you don't need an HDHP to qualify, although some HRAs require you to have some level of health insurance, such as a plan through the Health Insurance Marketplace or through your spouse's job, to participate.
How You Can Save Money Using HSAs and HRAs
Choosing an HDHP can lower the amount you pay for premiums, but it's important to make sure you can afford the high deductible. An HSA can help you do that. Money that would otherwise go to premiums is saved in an account you own, and unused money rolls over from year to year.
For example, the average employee contribution to an employer-sponsored family PPO is $6,636 per year, compared with $4,866 per year for an HDHP. By choosing the HDHP, you could reduce your share of the premiums by $1,770—enough to cover most HDHP deductibles. If you choose an HDHP that covers preventive care without requiring a deductible and you're in good health, you may not need to tap into the HSA for years. This could help you save a substantial sum to cover future medical emergencies or ordinary health care needs as you get older.
If your employer offers an HSA and contributes to your accounts, even better: You're getting free money to put aside for your health care. You can even withdraw the money for non-qualified expenses; however, you'll pay income taxes and a 20% tax penalty on the amount withdrawn.
Tax breaks are another key benefit of HSAs. HSA contributions are made pretax; you can take a federal tax deduction for contributions you make; and withdrawals are tax-free too. Some HSAs even let you invest the money in your account, with no federal taxes on any income you earn. (States differ in their tax treatment of HSAs, so be sure to find out what the rules are in your state.)
If your employer offers an HRA, you'll receive money that doesn't count as part of your income and isn't taxed when you withdraw it. Depending on plan type, your employer may give you the option to roll over your funds each year, so you won't lose unused money in the account. There are also plans that let you tap the HRA to buy your own health insurance.
By providing a way to save for medical expenses without purchasing an HDHP, an HRA gives you more choices for your health care.
Are HSAs and HRAs Worth It?
While HSAs and HRAs offer many benefits, there are some potential downsides to consider.
- You must have an HDHP to qualify for an HSA. Even though HDHPs have lower premiums, high deductibles mean your costs for health care could be higher than with a lower-deductible plan. Depending on how you use your health coverage, you could end up spending more money, not less.
- There are limits on how much you can save in an HSA. For 2020, the maximum you can contribute if you have self-only HDHP coverage is $3,500; the maximum contribution if you have family HDHP coverage is $7,000. If you're 55 or older, the limits go up by $1,000.
- There are no limits on how much can be contributed to an HRA. However, you have no control over the amount that's put into your account; only your employer does.
- Some HRAs require you to buy coverage through the Health Insurance Marketplace. Depending on your income, however, you may be eligible for a tax credit to help pay your coverage premiums. By participating in an HRA, you may be disqualified for the premium tax credit, or you might have to pay back your tax credit at the end of the year. Either of these may ultimately cost you more than the HRA saves you.
In general, employees who have access to an HRA aren't eligible to contribute to HSAs. However, certain types of HRAs are compatible with HSAs, so it is possible for employers to offer both. If yours does, is it better to participate in one, the other, or both? That depends on your situation, your health insurance plan and your finances. Your human resources department or the HSA and HRA providers your employer offers can help you work through your options. Healthcare.gov also offers a decision guide to help you assess your HRA choices.
Is an HRA or HSA Right for You?
Not everyone will qualify for an HSA or HRA. Even if you qualify, whether to participate is a complex decision. But if you do have the option to use an HSA or HRA to save for health care costs, it's worth investigating. Health care is expensive, and unpaid medical debt could negatively affect your credit score if it's sent to collections. A tax-advantaged health care savings account could be just what you need to cover the cost of qualified medical expenses and keep your credit score in good health.