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What FSA and HRA Plans Are and How They Work

Flexible Spending Accounts (FSAs) and Health Reimbursement Arrangements (HRAs) are employer-sponsored programs that help employees pay for medical expenses with pre-tax dollars. Understanding the difference between these two options is important because they work in different ways, even though both can lower your overall healthcare costs.

An FSA is an account where you set aside money from your paycheck before taxes are taken out. This money goes into your account, and you use it to pay for qualified medical expenses like copays, deductibles, prescriptions, dental work, and vision care. The key advantage is that you don't pay federal income tax or Social Security tax on the money you put into an FSA. For example, if you contribute $2,500 to an FSA and you're in the 22% tax bracket, you could save around $550 in taxes.

An HRA works differently because your employer funds it, not you. Your employer decides how much money to put into your account each year. You then use that money to pay for qualified medical expenses. Like FSAs, HRAs use pre-tax dollars, which means you also save on taxes. The difference is that with an HRA, your employer controls the contribution amount and the account rules.

Both plans cover similar medical expenses. According to the IRS, these include doctor visits, hospital stays, prescription medications, dental and orthodontia work, vision care, hearing aids, and medical equipment. Some plans may also cover over-the-counter items like pain relievers, allergy medicine, and first aid supplies, depending on the plan design.

Practical Takeaway: FSAs are employee-funded accounts where you choose how much to contribute, while HRAs are employer-funded accounts where your employer decides the amount. Both save you money by reducing the taxes you pay on healthcare spending.

FSA Contribution Limits and How Much You Can Save

The amount you can contribute to an FSA changes each year based on IRS regulations. For 2024, the maximum contribution limit is $3,200 per year. This limit applies to most workers, though some employers offer lower limits. It's important to know this number because contributing more than the limit could result in penalties.

To understand the real savings, let's look at an example. Suppose you expect to spend $2,000 on medical expenses in a year—perhaps $500 in copays, $600 in prescription costs, $400 in dental work, and $500 in glasses and vision care. If you contribute $2,000 to your FSA, you avoid paying taxes on that amount. If your combined federal and state tax rate is 25%, you save $500 by using an FSA instead of paying for these expenses with after-tax money.

However, FSAs come with an important rule: you must use the money by the end of the plan year or you lose it. This is called the "use-it-or-lose-it" rule. Some employers offer a grace period of up to 2.5 months into the following year, or they allow you to roll over up to $640 into the next year (as of 2024). You should check with your employer to see if either option is available to you.

Planning your FSA contribution is crucial. You need to estimate your medical expenses for the coming year. Look at your past medical bills, prescription costs, and planned procedures like dental work or vision exams. If you're unsure about future expenses, it's safer to contribute a smaller amount rather than risk losing unused funds. Many employers provide worksheets or tools to help you estimate your healthcare spending.

Practical Takeaway: Estimate your expected medical expenses for the year, then contribute that amount (up to $3,200 for 2024) to your FSA. The tax savings typically range from 20-40% depending on your tax bracket, but only if you use the money before the year ends.

Understanding HRA Rules, Vesting, and Employer Contributions

HRAs function under different rules than FSAs because employers have much more control over how they work. Your employer sets the contribution amount, decides which medical expenses are covered, and determines whether unused balances roll over to the next year. This flexibility for employers means HRA rules can vary significantly from one company to another.

One important concept with HRAs is "vesting." Vesting refers to whether you own the money your employer contributes. Some HRAs are "fully vested," meaning the money is yours to use immediately and belongs to you. Other HRAs have vesting schedules, where you earn the right to use the employer's contribution gradually. For example, an HRA might vest 25% each year, meaning you'd have full access to the funds after four years of employment. If you leave the company before the money is fully vested, you may lose some or all of the unused balance.

Another key difference is whether HRA balances carry over. Some HRAs allow unused funds to accumulate indefinitely, meaning you can build up a substantial balance over time. Others reset each year, similar to FSAs. Some HRAs use a "use-it-or-lose-it" approach, while others let you carry over a portion of your balance. Your employer's plan documents will specify which approach applies to your HRA.

Many employers are increasing their HRA contributions as healthcare costs rise. The average employer HRA contribution in 2023 was around $1,000 to $1,500 per employee, though this varies widely by industry and company size. Some employers contribute significantly more, especially for workers with higher deductibles or in expensive healthcare markets.

Practical Takeaway: Review your employer's HRA plan documents to understand the contribution amount, vesting schedule, and carryover rules specific to your plan. Ask your benefits department if you're unsure about any details.

Qualified Medical Expenses You Can Pay For

Both FSAs and HRAs cover a long list of qualified medical expenses as defined by the IRS. Knowing what you can and cannot pay for is essential to avoid spending account funds on ineligible items and facing tax penalties. The list includes obvious expenses like doctor visit copays and prescription medications, but also many expenses people don't always realize are covered.

Here are common qualified expenses that both FSAs and HRAs typically cover:

• Doctor, dentist, and eye doctor copays and deductibles
• Prescription medications and insulin
• Over-the-counter medications with a doctor's prescription, such as pain relievers, allergy medicine, and antacids
• Dental work including cleanings, fillings, crowns, and braces
• Vision care including eye exams, glasses, contact lenses, and eye surgery like LASIK
• Hearing aids and hearing-related care
• Medical equipment like crutches, wheelchairs, and blood pressure monitors
• Mental health and therapy services
• Fertility treatments and related procedures
• Medical transportation and parking at medical facilities
• Home healthcare services when medically necessary

Some expenses that people sometimes ask about are NOT covered by FSAs and HRAs. These include cosmetic procedures not related to an injury or medical condition, general fitness or gym memberships, over-the-counter medications without a prescription, and elective procedures not medically necessary. Vitamins and supplements are generally not covered unless they treat a specific medical condition and are prescribed by a doctor.

A helpful tool to determine whether an expense qualifies is IRS Publication 502, which provides a detailed list. Additionally, many FSA and HRA providers offer online resources or customer service teams that can answer specific questions about whether a particular expense qualifies.

Practical Takeaway: Keep receipts for all medical expenses you think might qualify. Before paying for a major expense from your FSA or HRA, confirm with your plan administrator that it's a qualified expense to avoid losing funds on ineligible costs.

How to Set Up and Use Your Account Throughout the Year

Setting up your FSA or HRA account typically happens during your employer's open enrollment period, which is usually once per year. If you're a new employee, you may have a window of 30