In order to accurately communicate about medical flexible spending accounts (FSAs) and health savings accounts (HSAs) to participants, employers must understand the basics of each.
While there are similarities between the two—both allow employees to contribute up to a certain amount to pay for out-of-pocket health care costs and in both, contributions are pre-tax and distributions are tax-free—there are some important differences, Sara Caddy, benefits manager at Dimensional Fund Advisors, told attendees of a webinar sponsored by the Plan Sponsor Council of America (PSCA).
A big difference is the “use-it-or-lose-it” feature of FSAs—funds must be used within the calendar year or they will be forfeited, with two exceptions. Caddy explained that the plan may provide for a 2.5-month grace period to spend or a balance carryover of up to $500. “This could lead FSA participants scrambling to spend their funds at the end of the year or grace period,” Caddy said. However, assets left over in HSAs can be carried over from year-to-year.
Amounts employees are allowed to contribute to HSAs are higher than for FSAs, and there are additional expenses for which employees can use HSA assets. COBRA premiums, long-term care insurance premiums and employer-sponsored Medicare Supplement/Advantage premiums can be paid with HSA assets, Caddy said.
HSAs are considered “triple-tax-advantaged” because contributions are made pre-tax (federal, state, FICA and FICA-Med); earnings are tax deferred; and payouts are tax-free if used for qualifying expenses (otherwise payouts are subject to income taxes and a 20% penalty tax if paid prior to age 65). However, there is no excise tax for nonqualified plan expenses after age 65.
There is also a difference between when participants can change contribution amounts. Participants have to estimate what their out-of-pocket spending will be for the year and make an election for contributions prior to the year, Caddy explained. The only way contributions to an FSA can be changed during the year is due to a qualifying event. However, contribution amounts to HSAs may be adjusted any time during the year, “so there is no need to predict what a participant will spend on medical expenses,” Caddy said.
According to Caddy, employees can have one or the other, not both an FSA and HSA, except for limited purpose FSAs which are strictly for out of pocket vision and dental, not all medical expenses. She also reminded webinar attendees that HSAs can only be offered in conjunction with an HSA-eligible high-deductible health plan, and while employees can take HSAs with them if they leave their employer, they may not contribute to their HSAs if it is not paired with an HSA-eligible plan.
A big difference is that HSA assets can be invested, and this is something Caddy recommends. She also said it helps HSA participants see them as a long-term savings option. “I recommend saving for out-of-pocket medical expenses upon retirement. I’d much rather use tax-free HSA funds for Medicare and/or long-term care insurance premiums,” she stated.
Communicating HSAs as a long-term savings option
Caddy suggested that when communicating to plan participants about HSAs, employers should highlight what the ‘S’ stands for—“savings,” versus “spending” in FSAs. She also recommended employers reiterate to employees that the primary expense that increases after retirement is health care. Remind employees that HSA assets left in the account will be rolled over from year-to-year.
As for plan design, Caddy said plan sponsors should make sure HSA-eligible plan premiums are at least the same if not lower than other health plan offerings and make sure the benefits covered are the same for each plan, to encourage participation in these plans.
In the associated HSAs, “employers should encourage employees to save at least to their deductible amount…that’s not hard; then to the maximum out-of-pocket expenses,” Caddy said. “Some say employees should contribute an amount to receive the entire employer match in a defined contribution plan, then turn to HSAs, but I wouldn’t recommend one over the other. I would advocate for saving in both at the same time.”Finally, employees should be reminded that if they are lucky enough not to need HSA assets for medical expenses after retirement, they can access the money for any expense desired, subject to regular income taxes.