Tax-Protected Accounts

Cafeteria plans

By providing flexible spending arrangements (FSAs), better known as cafeteria plans, employers allow employees to establish and contribute money to an account for health care expenses. Employees make a pre-tax contribution to the account it each pay period. Employees pay for their health care expenses (whether that’s a deductible, co-pay or other fee not covered by insurance), then submit receipts for reimbursements from their cafeteria account.

Unused funds in an FSA cannot be rolled over to the next benefit year. These funds are often referred to as “use it or lose it” money. That’s why it’s important for employees, at the beginning of each year, to carefully calculate how much to contribute each pay period.

Health savings accounts (HSA)

A health savings account (HSA) is similar to a cafeteria plan, but there are several differences. To open an HSA, a consumer must be covered by a high-deductible health plan (HDHP). Sometimes referred to as “catastrophic” health coverage, an HDHP is a plan with lower monthly premiums that often has a deductible of several thousand dollars. The deductible is the expense the consumer must pay before the health plan starts paying benefits.

If you’re a small business owner shopping for group health insurance coverage, you may choose an HDHP because of the cost savings to you. In this scenario, your employees will likely be eligible to set up HSAs if they choose.

Deposits to the HSA are tax-deductible and can be made either by you (the employer), the employee or anyone else. The federal government limits how much money can be contributed to the account each year. Consult the IRS or your accountant for the current limits. Unlike cafeteria plan money, HSA funds roll over and accumulate year to year if not spent during the current year.

The HSA can also serve as an investment for future expenses. They earn interest, and like an IRA, these earnings are not taxable until the money is withdrawn. Withdrawals spent on anything other than medical expenses face a penalty.

Since the IRS determines whether withdrawals are in compliance with the guidelines, account holders are required to retain documentation for their qualified medical expenses.

As with most financial accounts, when a person dies, the funds in the HSA are transferred to the beneficiary named for the account. If the beneficiary is a surviving spouse, the transfer is tax-free.

Health reimbursement account (HRA)

An HRA is similar to an HSA, in that it is used to pay an employee’s medical expenses not covered by a group plan. However, the similarity ends there.

Only the employer makes contributions to the account. The funds are used to reimburse employees after they pay expenses for their health care. There is no annual limit on contributions. An employer can set up an HRA for employees regardless of the type of insurance they have, or if they have no insurance.

An employer sets up an HRA for an individual employee. The employer works with a third-party administrator to open the account and set rules dictating what employee medical costs will be reimbursed, such as deductibles, co-pays, dental services, etc. Contributions made into the employee’s HRA are not considered taxable income to the employee.

The employer decides if any funds remaining at the end of the year roll over to the next year and the amount allowed to rollover. The employer’s other option is to designate unused funds as “use it or lose it,” similar to cafeteria plan funds.

 In general, reimbursements from an HRA can be made to current and former employees and their spouses and dependents.

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