Open Season: FSAs, HSAs and Health Reimbursement Arrangements

An important decision that employees have to make during the 2014 federal benefits “open season” is whether they want to enroll or reenroll in a health care flexible spending account (HCFSA) and a Dependent Care Flexible Spending Account (DCFSA) for the 2015 plan year. This week we examine  the HCFSA and the DCFSA and how they benefit employees.

Employees who choose not to enroll in an HCFSA may be eligible to enroll in a Health Savings Account (HSA) or a Health Reimbursement Account (HRA). The HSA and the HRA are also discussed below.

Health Care FSAs and Dependent Care FSAs

An HCFSA allows an employee to be reimbursed for out-of-pocket medical, dental or vision expenses. Employees who work for an executive branch agency or an agency that has adopted the Federal Flexible Benefits Plan ("FedFlex") can elect to participate in the federal flexible spending account program, called the FSAFEDS program.

Employees who participate in the FSAFEDS program save money through the reduction of a portion of their gross salary to pay their health care-related expenses. The HCFSA can be thought of as a savings account that pays in a tax-beneficial way for items typically not paid for, or covered by a Federal Employees Health Benefits (FEHB) program plan, by a Federal Employees Dental and Vision Insurance Program (FEDVIP) plan, or by other medical, dental or vision insurance coverage.

The money contributed to an employee’s HCFSA and/or DCFSA is set aside before federal and state income taxes, and Social Security (FICA) and Medicare Part A (hospital insurance) payroll taxes are deducted, resulting in overall tax savings ranging from 20 percent to 50 percent. The average tax savings for an employee earning $50,000 who contributes $2,000 to an HCFSA is approximately $600. That means the employee gets $2,000 worth of health care purchasing power plus saving about $600 in overall taxes.

An employee must be eligible to enroll in, though not necessarily enrolled in, the FEHB program in order to enroll in an HCFSA. FEHB eligibility is not required to enroll in a DCFSA. The DCFSA is a separate account and is available to reimburse employees for the cost of qualifying dependent care expenses of a tax dependent. A maximum of $5,000 can be contributed to a DCFSA.

The HCFSA reimburses qualified health care expenses not covered or reimbursed by a FEHB program plan, a FEDVIP plan, or any other insurance program that an employee may be enrolled in including Tricare or a spouse’s private company-sponsored health insurance plan. The eligible expenses of the employee, the employee’s spouse, and the eligible tax dependents (including adult children through the end of the calendar year in which they become age 26) may be reimbursed through the HCFSA. Employees can contribute annually to their HCFSA from a minimum of a $100 (new for plan year 2015 and reduced from $250) to a maximum of $2,550 (increased from $2,500 from 2014). Spouses of employees who are also federal employees can also contribute annually a maximum of $2,550 to an HCFSA during 2015.

Qualified medical expenses are those specified in the plan that would generally qualify for the medical and dental expense deduction on an individual’s tax return. These expenses are explained and presented in IRS Publication 502, “Medical and Dental Expenses,” which can be downloaded at www.irs.gov. Also, non-prescription medicines other than insulin are not considered qualified medical expenses for HCFSA reimbursement purposes. A medicine or drug will be a qualified medical expense for HCFSA reimbursement purposes only if the medicine or drug: (1) Requires a prescription; (2) is available without a prescription (an over-the-counter medicine or drug) and the individual gets a prescription for it; or (3) is insulin. Insurance premiums, however, may not be reimbursed from an HCFSA.

The FSAFEDS program on its website provides a “juke box” showing which medical, dental and vision expenses are eligible for reimbursement, potentially reimbursable, and not reimbursable from FSAFEDS. The “juke box” is available at www.fsafeds.com/fsafeds/EligibleExpenses.asp.

Those employees who are enrolled in a High Deductible Health Plan (HDHP) with an HSA are not eligible to enroll in an HCFSA. But these employees may be eligible for a “limited expense” flexible spending account or a “LEX HCFSA”. A LEX HCFSA reimburses employees for eligible dental and vision expenses not covered or reimbursed by the FEHB and FEDVIP programs or other insurance programs.

To be eligible for a LEX HCFSA, an employee must be enrolled in an HDHP during 2015 and contribute to an HSA during 2015. The employee can request reimbursement from the HSA for qualifying dental and vision expenses incurred by the employee, by the employee’s spouse and tax dependents (including adult children through the end of the calendar year they become age 26). There is an annual maximum contribution to a LEX HCFSA of $2,550 per employee. An employee’s spouse who is also a federal employee can have a separate LEX HCFSA with a maximum contribution amount of $2,550.

Eligible employees can enroll in FSAFEDS each year during the federal benefits open season. This year’s federal benefits “open season” enrollments are being held from Nov. 10 through Dec. 8. Enrollment is done on the FSAFEDS website at www.FSAFEDS.com. Elections made during open season will be effective Jan. 1, 2015. Eligible expenses for reimbursement must be incurred between Jan. 1, 2015, and Dec. 31, 2015. Effective with the 2015 plan year, HCFSA owners are able to carry over up to $500 of unspent funds into the next benefit year.

Current enrollees in FSAFEDS must remember to enroll each year to continue participation in FSAFEDS for the next plan year. Enrollment in the HCFSA and the DCFSA does NOT carry forward year to year. New and newly eligible employees who wish to enroll in this program must do so within 60 days after they become eligible, but before Oct. 1 of the calendar year.

For further information about the HCFSA, the LEXFSA and the DCFSA, employees should go to www.FSAFEDS.com or call 1-877-372-3337; TTY 1-800-952-0450.

Health Savings Accounts

A health savings account is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high deductible health plan (HDHP). The funds contributed to an HSA are not subject to federal or state income tax at the time of deposit. Unlike an HCFSA, HSA deposits earn interest or dividends. Unused HSA funds roll over and accumulate year to year. HSAs are owned by the individual, which differentiates them from an employer-owned Health Reimbursement Arrangement (HRA) (see below) which also uses before-tax dollars to pay qualifying medical expenses.

An HDHP features higher annual deductibles (for 2015, a minimum of $1,300 for self only and $2,600 for self and family coverage) compared to other traditional health plans. The maximum annual out-of-pocket spending amounts (based on IRS rules) for HDHPs participating in the FEHB program in 2015 are $6,450 for self only enrollment and $12,900 for self and family enrollment. Depending on the HDHP an enrollee chooses, the enrollee may have the choice of using in-network and out-of-network providers. Using in-network providers will likely save money. With the exception of preventive care, an enrollee must meet the annual deductible before the plan pays benefits. Preventive care services are generally paid as “first dollar coverage,” or after a small deductible or copayment.

When an employee enrolls in an HDHP, the health plan determines if the enrollee is eligible for an HSA or for an HRA. Those employees who are enrolled in or are covered by a non-HDHP plan, or who are enrolled in Medicare, are not eligible to participate in an HSA.

Each month, the plan automatically credits a portion of the health plan premium into HDHP enrollee’s HSA or HRA, based on the enrollee’s eligibility as of the first day of the month. An enrollee can pay their deductible with funds from their HSA or HRA. If an employee has an HSA, the employee can also choose to pay their deductible amount out-of-pocket, thereby allowing their HSA to grow. An HSA owner can contribute additional amounts to the HSA up to the annual limit. For 2015, the annual HSA contribution amount (this includes the automatic FEHB HDHP contribution) is $3,350 for self only coverage and $6,650 for self and family coverage. HSA owners age 55 and older during 2015 may contribute an additional $1,000 in “catch-up” contributions.

The following table summarizes HSA limits for 2015:

HSA participants do not have to obtain advance approval from their HSA custodian/trustee or their medical insurer to withdraw funds from their HSA, and the funds withdrawn from the HSA are not subject to income taxation if they are made to pay qualified medical expenses. These withdrawals include reimbursements for medical services and items covered by the health plan but subject to cost sharing such as a deductible and coinsurance or copayments, as well as many other expenses not covered under medical plans, such as dental, vision and chiropractic care; durable medical equipment such as eyeglasses and hearing aids; and transportation expenses related to medical care. Through Dec. 31, 2010, non-prescription over-the-counter medications were also eligible. Beginning Jan. 1, 2011, the Patient Protection and Affordable Care Act, also known as Health Care Reform, stipulates HSA funds can no longer be used to buy over-the-counter drugs without a doctor's prescription. HSA withdrawals can be made to pay long-term care insurance premiums.

There are several ways that funds in an HSA can be withdrawn. Some HSAs include a debit card, some supply checks for account owner use, and some allow for a reimbursement process similar to medical insurance. Most HSAs have more than one withdrawal options, and the options available vary from HSA to HSA. Checks and debits do not have to be made payable to the provider. Funds can be withdrawn for any reason, but withdrawals that are not for documented qualified medical expenses are subject to income taxes and a 20 percent penalty. The 20 percent tax penalty is waived for individuals who have reached the age of 65 or have become disabled at the time of the withdrawal. In that case, only income tax is paid on the withdrawal, and in effect the account has grown tax deferred (similar to an IRA). Prior to Jan. 1, 2011, when new rules governing HSAs in the Patient Protection and Affordable Care Act went into effect, the penalty for non-qualified withdrawals was 10 percent.

Account holders are required to retain documentation of their reimbursed medical expenses. Failure to retain and provide documentation could cause the IRS in an audit to rule withdrawals were not made to pay for qualified medical expenses and subject the withdrawals to taxes and additional penalties.

There is no deadline for reimbursements of qualified medical expenses. High-income individuals can take advantage of this by paying for medical costs out of pocket, retaining receipts and allowing their accounts to grow tax-free. Withdrawals from the HSA for reimbursement can be made years later, up to the value of the receipts. This means that unlike an HCFSA, HSA owners retain ownership of and can use the HSA if they were to leave federal service or after they retire from federal service. For example, a federal annuitant who has an HSA could make withdrawals to pay monthly Medicare Part B premiums or to pay long-term care insurance premiums.

When an HSA account owner 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 Accounts

If an employee enrolls in an HDHP and is not eligible for an HSA, the employee will be given a Health Reimbursement Account. The HDHP will credit a portion of the health plan premium to the employee’s HRA; these are called HRA “credits” The amount of HRA credits for either a self only enrollment or a self and family enrollment will be the same as the amounts that will be deposited in HSAs in the same plan. An HRA owner can use funds in an account, for example, to pay the HDHP deductible and other qualified medical expenses that do not count toward the deductible. Withdrawals from an HRA account can be used to pay Medicare Part B premiums.

Features of an HRA include: (1) Tax-free withdrawals to pay or to reimburse for qualified medical, dental or vision expenses; (2) carryover of unused credits without limit from year to year; (3) credits in an HRA do not earn interest; (4) credits in an HRA are forfeited if the HRA owner switches health plans, or if the HRA owner leaves federal employment other than to retire; and (5) the HRA is administered by the health plan

Medical benefits paid by HRAs that meet certain requirements are not taxable to the employees. The basic requirement is that the account must be funded solely by the employer, and only substantiated medical expenses can be reimbursed.

A comparison chart for the HSA, HRA and HCFSA is presented on the OPM website at: http://www.opm.gov/healthcare-insurance/healthcare/health-savings-accounts/comparison-chart/.

See more information-filled Open Season columns in Federal Soup each Wednesday in the weeks ahead from federal employee benefits expert Edward A. Zurndorfer, author of Federal Employees News Digest ’s weekly Informed Investor column.

View our Open Season Checklist