Comparing Health Reimbursement Arrangements with Health Savings Accounts
Note for 2014: I recommend a flexible benefit plan design that accommodates a combination of tax-free and after tax health benefits as allowed under the Affordable Care Act and prior law without the need to revise the benefit plan documents as tax regulations continue to evolve.
Two types of cost-saving health plans jockey for the attention of small businesses attempting to revise their small group health plans. Both of these plans can significantly cut costs and improve health plan quality for the employees of small businesses. But the two plans are very different in suitability and fit for specific business purposes. In some cases it is possible to use both plans in combination for maximum health coverage and tax savings.
FreedomBenefits.org offers small businesses with assistance in the design, documentation and setup of these plans. The typical charge is $75 to $150 for the smallest companies.
The key distinctions are that HRAs are paid and controlled solely by the employer and do not incorporate employee contribution. HSAs allow more flexible contribution and allow employee contributions and management. IRS requirements for HRAs are flexible than HSA. HRAs may require employers to take action to address employee privacy issues where HSAs avoid this issue.
When HSAs and HRAs are used in combination, the IRS requires that the HRA be limited to prevent overlap of benefits. This is called a “Limited Purpose HRA”.
HSAs require a specific type of health insurance that is not available to everyone. In fact, more than half of the people who apply for a HSA plan are not accepted at standard rates. These who do not qualify for the health insurance do not qualify for the tax-free savings account. Only healthy people without significant medical history find HSA plans to be a bargain. HRAs do not require any type of health insurance.
HSAs are best for sole proprietors, partners and owners of S-corporations because this is the only plan that will allow a business tax deduction in advance of actually incurring any health claims. HSAs can even be used as a tax shelter in this regard. HRAs are not available to this group of business owners.
HSAs do not work well when converting group coverage for employees from a group HMO plan. Employees tend to become accustomed to the mindset of how an HMO works, and HSA work exactly in the opposite way. It is not an issue of one plan being better or worse, but rather the fact that employees strongly resist changes of this magnitude in their benefit plan. The amount of money that may be saved in changing plans is probably not worth the pile of complaints employees will pour on the boss.
When a business pays most of the cost of health coverage for employees, the HRA plan will almost always save money and make the employees happier than a HSA plan or traditional health plan.
The HSA and HRA may be used in conjunction with a Section 125 Cafeteria plan, but the suitability will be determined by the size of the business and the degree of reliance on employer contributions vs. employee voluntary contributions. This should be taken up on a case-to-case basis.
All of these plans require written documentation, just like other tax-qualified employee benefit plans. Plan documents, summary descriptions, corporate resolutions and administrative manuals are available free of charge to the clients of FreedomBenefits.org.
In summary, HSAs tend to work best for healthy self-employed individuals while HRAs work best when an employer pays for health benefits for employees. In many cases a combination of both is the best option. Either plan or the combination plan may be easily managed by small business owners through the use of affordable professional online services.
The IRS provides more information about HRAs and HSAs for small business in Publication 969.