Consumer-Directed Health Plans: Following the Money

Aug 1, 2008
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08/08 HR Magazine CoverOne of the distinguishing characteristics of consumer-directed health plans is how employees’ medical expenses are paid. The two principal methods are health reimbursement arrangements and health savings accounts. Both approaches are outlined in the chart beginning on page 76, “Types of Tax-Favored Health Accounts.” 

In addition, here are further descriptions of how these two relatively new types of health spending accounts are structured and how they differ from each other.

Health Reimbursement Arrangement

A health reimbursement arrangement (HRA) is established by the employer and is designed to reimburse employees for qualified medical expenses that are either:

  • Applied to the deductible.

  • The employee’s share of co-pays or co-insurance.

As medical expenses are incurred, they are initially applied to the deductible, the same as in any other form of health plan described on page 72. Participants may then draw unreimbursed funds from their HRA account balances.

Although employers are not required to couple an HRA with a high-deductible health plan, in practice the two are typically combined. HRA-based plans are only offered by employers to employees, and only employers may contribute to tax-advantaged HRA accounts.

Account balances can accrue from year to year. Employees do not own the accounts and typically do not retain unspent funds when they change jobs. At the employer’s discretion, a former employee may tap unused funds to pay COBRA premiums and retiree health care premiums.

HRAs are administered by the employer, a third-party administrator or an insurance carrier.

Health Savings Account

A health savings account (HSA) is established for paying qualified medical expenses on a tax-free basis (or for any other purpose on a taxable basis), but it is the employee, not the employer, who owns the account. Individuals and the employer are eligible to open and fund an HSA when the employee has a high-deductible, HSA-qualifying plan and no other health coverage (with limited exceptions).

To be considered HSA-eligible, a health plan must meet certain criteria, including a minimum deductible amount -- $1,100 for single coverage and $2,200 for family coverage in 2008 -- and a maximum limit on out-of-pocket spending, which is $5,600 for single coverage and $11,200 for family coverage in 2008. For 2009, the minimum deductible amounts will be $1,150 for self-only coverage and $2,300 for family coverage, and the limits on out-of-pocket spending (deductibles, co-payments and other amounts, but not premiums) will be $5,800 for self-only coverage and $11,600 for family coverage.

Preventive-care services and dental and vision coverages may be exempted from the deductible requirement; however, coverage of most other services, including prescription drugs, must be subject to the deductible.

Health insurance carriers offer HSA-eligible plans to employers in the group market and to individuals in the individual market. HSA-eligible plan enrollees are not required to open or contribute to an associated HSA. A financial institution, such as a bank or insurance company, typically serves as a trustee and administers the HSA. An employer may partner with a financial institution to offer an HSA alongside the HSA-eligible plan offered to employees, or it may defer to employees to open accounts.

Both employers and individuals may contribute to HSAs. Individuals can either contribute to an HSA on a pretax basis through an employer’s Section 125 plan, if available, or they may claim a deduction on their federal income taxes for the HSA contribution regardless of whether they itemize deductions or claim the standard deduction. Account balances can accrue without limit, and the accounts are fully portable.

Contributions, withdrawals and interest earned on the accounts are not federally taxed if used for eligible health care expenses; individuals are responsible for “validating” HSA expenses by keeping receipts and other paperwork. Enrollees may use accrued balances for purposes other than medical care subject to a tax penalty and, for retirement income, subject to income tax.

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