Understanding HSAs and FSAs

Health Savings Account (HSA)

As explained by the IRS, a health savings account is a tax-exempt trust or custodial account used to “pay or reimburse certain medical expenses you incur; you must be an eligible individual to qualify for an HSA.” Companies don’t need authorization from the IRS to establish one. Companies can just set one up with a trustee, typically a bank or an insurance company.

There are several powerful advantages for your employees:

• Contributions to an HSA made by an employer (including contributions made through a cafeteria plan) may be excluded from gross income.
• The contributions remain in an employee’s account until they’re used.
• The interest or other earnings on the assets in the account are tax-free.
• Distributions may be tax-free if you pay qualified medical expenses.
• Employees can change contribution levels throughout the year.
• An HSA is “portable.” It stays with your employees even if they leave your company or the workforce.

To offer your employees such a plan, however, you have to offer a high-deductible health plan, which, as the name says, has a higher deductible than is typical. In brief, the HSA and HDHP are designed to work in partnership to provide full coverage.

Flexible Spending Account (FSA)

A FSA has much the same purpose as an HSA but operates under different rules. Under such a plan, your employees set aside a certain amount of money for medical expenses:

• No federal or employment taxes are deducted from this amount.
• An employer may contribute, but doesn’t have to.
• Withdrawals may be made tax-free.
• Money may be spent in advance, as long as the employee has made a commitment to the salary reduction agreement.
• Unlike with HSAs, these are “use it or lose it” plans. With few exceptions, money not spent at the end of the calendar year is lost.
• Employees can’t alter their annual contribution amounts unless there is a major family change.

From the employer’s viewpoint, the FSA is easier to set up. It can be offered in conjunction with other plans and is not bound to a HDHP the way an HSA is.

Can You Offer Both?

In word, no. The government allows employers to offer only one or the other. However, it does offer a small loophole: an employer may offer a “limited purpose” FSA in conjunction with an HSA. Such a limited plan may be applied just to dental or vision expenses, for example.

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