Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison

Tax-Advantaged Accounts for Health Care
Expenses: Side-by-Side Comparison
Bob Lyke and Chris L. Peterson
Domestic Social Policy Division
Summary
Health Savings Accounts (HSA) are the newest addition to an array of tax-
advantaged accounts that people can use to pay for unreimbursed medical expenses,
such as deductibles, copayments, and services not covered by insurance. First available
January 1, 2004, HSAs have largely replaced the similar but more restrictive Archer
Medical Savings Accounts (MSAs), which never attracted many participants. In
addition, people may have access to two employment-based accounts, Health
Reimbursement Accounts (HRAs) and health care Flexible Spending Accounts (FSAs).
Collectively, these accounts have some features and objectives in common, but they also
differ in important respects. Keeping these accounts straight can be difficult, especially
when they are discussed informally using different names.
This report provides brief summaries and background information about the four
accounts and then compares them with respect to eligibility, contribution limits, use of
funds, and other characteristics for tax year 2008. The report concludes with a brief
discussion of equity and several other issues. It will be updated when changes occur.
Brief Summaries and Background
Four types of tax-advantaged accounts are permitted under current law for people to
pay unreimbursed medical expenses such as deductibles, copayments, and services not
covered by insurance: health care Flexible Spending Accounts, Health Reimbursement¹
Accounts, Health Savings Accounts, and Archer Medical Savings Accounts.
Flexible Spending Accounts (FSA). Health care FSA are employer-established
arrangements that reimburse employees for medical and dental expenses not covered by
insurance or otherwise reimbursable. They usually are funded through salary reduction

¹ For additional general information, see Internal Revenue Service publication 969, Health
Savings Accounts and Other Tax-Favored Health Plans, available at [http://www.irs.gov].

agreements under which employees receive less pay (e.g., $100 less a month) in exchange
for equivalent contributions to their accounts (in this case, $1,200 for the year).
Employees choose how much to put into their accounts, which can vary from year to year.
They forfeit unused balances at the end of the year unless the employer offers a grace
period for additional claims of up to 2½ months after the end of the year (e.g., so medical
expenses incurred by March 15, 2009, could be reimbursed from the FSA for 2008). A
limited, one-time rollover may be made to a Health Savings Account. The entire annual
amount of an FSA must be made available to employees at the beginning of the year.
Contributions are not subject to income or employment taxes (i.e., Social Security and
Medicare taxes), unlike the pay employees otherwise would have received.
FSAs funded by salary reductions are governed by Section 125 of the Internal
Revenue Code, which exempts contributions from taxes despite the fact that employees
have the choice to receive taxable wages.² Most rules regarding FSAs are not spelled out
in the Code; they were included in proposed regulations that the Internal Revenue Service
(IRS) issued in 1984 and 1989. Final rules regarding permissible mid-year election
changes were issued in 2000 and 2001. On August 3, 2007, the IRS issued new proposed
rules that will generally be effective on January 1, 2009, though taxpayers may adopt them
sooner. These rules have not yet been finalized. FSAs are available to more than one-
fifth of private-sector workers (typically in larger establishments) and nearly half of
government workers (including federal employees), though participation rates are
substantially lower.³
Health Reimbursement Accounts (HRA) are also employer-established
arrangements to reimburse employees for medical and dental expenses not covered by
insurance or otherwise reimbursable. As is the case with FSAs, contributions are not
subject to either income or employment taxes. However, contributions cannot be made
through salary reduction agreements; only employers may contribute. Employers need
not actually fund HRAs until employees draw upon them. Also unlike FSAs,
reimbursements can be limited to amounts previously contributed. Unused balances may
be carried over indefinitely, though employers may limit the aggregate carryovers. A
limited, one-time rollover may be made to a Health Savings Account.
HRAs are governed by Section 105 of the Internal Revenue Code, which allows
health plan benefits used for medical care to be exempt from taxes, and Section 106 of
the Code, which allows employer contributions to those plans to be tax-exempt. Rules⁴
regarding HRAs are spelled out in IRS revenue rulings and notices issued in 2002.
Health Savings Accounts (HSA) are tax-exempt accounts for paying medical and
dental expenses not covered by insurance or otherwise reimbursable. They can be
established and contributions made only when the owner has qualifying high deductible

² Section 125 governs cafeteria plans; it provides an express exception to the constructive receipt
rule, which requires taxation of what is normally nontaxable income when taxpayers have the
choice of receiving taxable income or nontaxable income.
³ FSA rules are available at 49 Federal Register 19321 and 50733; 54 FR 9460, 65 FR 15548;
and 66 FR 1837. Also see IRS Revenue Ruling 2003-102. For data on the use of FSAs, see CRS
Report RL32656, Health Care Flexible Spending Accounts, by Chris L. Peterson and Bob Lyke.
⁴ IRS Revenue Ruling 2002-41 and Notice 2002-45.

insurance (a deductible of at least $1,100 for self-only coverage and $2,200 for family
coverage, plus other criteria) and no other coverage including Medicare, with some
exceptions. Contributions are limited to $2,900 for self-only coverage and $5,800 for
family coverage. An additional contribution of $900 is allowed people age 55 and older.
(The dollar amounts in the last several sentences are for 2008.) HSAs carry tax
advantages that can be significant for some people. Contributions made by employers are
exempt from income and employment taxes; account owners may deduct contributions
they make. Withdrawals for medical expenses are not taxed; those used for other
purposes are taxable and subject to an additional 10% penalty except in cases of disability,
death, or attaining age 65. Unused balances may be carried over from year to year without
limit. As of January 2007, nearly 4.5 million people were covered by HSA-high
deductible health plans. The number includes policy-holders (not all of whom may have
had HSAs) as well as their family members.⁵
HSAs were first authorized by the Medicare Prescription Drug, Improvement, and
Modernization Act of 2003 (MMA, P.L. 108-173). Most statutory rules are in Section

223 of the Internal Revenue Code, though there is IRS revenue guidance as well.⁶

Archer Medical Savings Accounts (MSA) might be viewed as a restricted
precursor to HSAs. Like them, MSAs can be established and contributions made only
when account owners have qualifying high deductible insurance and no other coverage,
with some exceptions. Contributions made by employers are exempt from income and
employment taxes, while contributions made by account owners (allowed only if the
employer does not contribute) are deductible. Withdrawals are not taxed if used for
medical expenses; those used for other purposes are taxable and generally subject to an
additional 15% penalty. Unused balances may be carried over from year to year without
limit. The principal difference is that eligibility is limited to people who are self-
employed or who are employees covered by a high deductible plan established by their
small employer (50 or fewer employees, on average). In addition, the minimum
deductible levels are higher and the contribution limits are lower. For details, see the
comparison table that follows.
MSAs were first authorized by the Health Insurance Portability and Accountability
Act of 1996 (P.L. 104-191). That legislation also set a deadline for establishing new
accounts and generally limited the total number to 750,000 (not counting accounts of
owners who were previously uninsured, among others), though for tax year 2003 the IRS
estimated there were fewer than 80,000 accounts in total. Later amendments extended the
deadline for new accounts to December 31, 2007, with some exceptions. However, most
MSA owners can now have HSAs, and their MSA balances can be rolled over into the
new accounts. Most statutory rules governing MSAs are in Section 220 of the Internal
Revenue Code.

⁵ The number is based on a survey by America’s Health Insurance Plans. For more information,
see [http://www.ahipresearch.org/PDFs/FINAL%20AHIP_HSAReport.pdf].
⁶ For additional information, see CRS Report RL33257, Health Savings Accounts: Overview of
Rules for 2008, by Bob Lyke.

CRS-4
Summary of General Features of FSAs, HRAs, HSAs, and MSAs, 2006
^H^e^a^l^t^h^Ca^{re F}^l^{exible Spending}^H^e^a^l^t^h^Reim^bursem^e^nt^H^e^a^l^t^h^Sa^vⁱ^ng^{s Acco}^unt^s^M^e^dica^{l Sa}^vⁱ^ng^{s Acco}^unt^s
^Acco^unt^{s (}^F^SA)^Acco^{unts (HRA)}^(HS^A⁾^{(Archer M}^S^A)
^ib^ility^Em^p^l^o^y^{ees w}^h^o^s^{e em}^p^l^o^y^er^s^Em^pl^oy^ees^w^h^os^{e em}^pl^oy^ers^Iⁿ^dⁱ^vⁱ^d^u^{als w}^ith^q^u^alif^yⁱⁿ^g^h^ealth^Iⁿ^dⁱ^vⁱ^d^u^{als w}^ith^q^u^alif^yⁱⁿ^g^h^ealth
^o^f^f^e^r^th^{is b}^eⁿ^e^f^{it. Fo}^r^m^er^o^f^f^e^r^th^{is b}^eⁿ^e^f^{it. Fo}^r^m^erⁱⁿ^su^r^aⁿ^{ce. I}ⁿ^elig^ib^{le in}^dⁱ^vⁱ^d^u^{als m}^a^yⁱⁿ^s^u^ran^{ce w}^h^{o are em}^ploy^ees^of^{a s}^m^all
^em^ploy^ees^m^a^y^{be in}^clu^d^ed.^em^ploy^ees^m^a^y^{be in}^clu^d^ed.^k^{eep prev}^iou^s^ly^es^tablis^h^e^{d accou}ⁿ^t^s^bu^t^em^pl^oy^{er (50 or f}^e^w^e^{r w}^o^rk^ers⁾^wⁱ^t^h^a
^c^a^nno^t^m^a^ke^c^o^nt^rⁱ^b^u^tⁱ^o^ns.^hⁱ^g^h^dedu^ctⁱ^b^l^e^pl^an^{or s}^e^l^f^-^e^m^p^l^o^y^e^d.^Em^ploy^ersⁿ^o^{t res}^t^{ricted by}^sⁱ^ze.^Em^ploy^ersⁿ^o^{t res}^t^{ricted by}^sⁱ^ze.
^Iⁿ^elig^ib^{le in}^dⁱ^vⁱ^d^u^{als m}^a^y^k^eep
^prev^iou^s^ly^es^tablis^h^e^{d accou}ⁿ^t^s^bu^t
^c^a^nno^t^m^a^ke^c^o^nt^rⁱ^b^u^tⁱ^o^ns.
ⁱⁿ^itioⁿ^o^f^{No h}^ealthⁱⁿ^s^u^ran^{ce requ}^irem^en^ts^.^N^{o h}^ealthⁱⁿ^s^u^ran^{ce requ}^irem^en^ts^,^Self^-^o^nly^deductⁱ^ble^m^u^s^t^{be at leas}^t^Self^-^o^nly^deductⁱ^ble^m^u^s^t^{be at leas}^t
^alif^yⁱⁿ^g^a^l^t^h^o^{ugh H}^R^A^s^a^r^e^usua^l^l^y^$1,100;^t^h^e^f^a^m^ily^deductⁱ^ble^mu^s^t^b^e^{$1,950 bu}^tⁿ^o^t^ov^{er $2,900;}^t^h^e^f^a^m^ily
^co^m^bⁱⁿ^ed^w^ith^hⁱ^g^h^d^e^d^u^ctib^le^at^l^eas^t^{$2,200. A}^nnua^l^o^u^t^-^o^f-p^o^c^ke^t^deductⁱ^ble^m^u^s^t^{be at}^l^eas^t^{$3,850 bu}^t
^r^aⁿ^c^e^h^ealthⁱⁿ^su^r^aⁿ^ce.^e^x^p^e^nse^s^fo^r^c^o^ve^r^e^d^b^e^ne^fi^t^s^c^a^nno^tⁿ^o^t^ov^{er $5,800. A}^nnua^l^o^u^t^-^o^f-p^o^c^ke^t
^ex^{ceed $5,600 f}^o^r^s^e^l^f-on^l^{y coverage}^e^x^p^e^nse^s^fo^r^c^o^ve^r^e^d^b^e^ne^fi^t^s^c^a^nno^t
ⁱ^{ki/CRS-RS21573}^an^{d $11,200 f}^o^r^famⁱ^l^y^coverage^.^ex^{ceed $3,850 an}^{d $7,050, res}^p^ectiv^ely^.
^g/w^Ded^u^ctib^{le n}^eedⁿ^o^{t ap}^p^l^y^to^p^r^ev^en^tiv^e^Ded^u^ctib^{le n}^eedⁿ^o^{t ap}^p^l^y^to^p^r^ev^en^tiv^e
^s^.or^care.^{care if}^abs^eⁿ^{ce of}^dedu^{ctible is}^requ^ired
^le^ak^by^s^t^{ate law}^.
^://wikiⁿ^t^ri^bu^tⁱ^oⁿ^s^By^em^pl^oy^{er, em}^pl^oy^{ee, or bot}^h^.^U^s^u^a^l^l^y^f^uⁿ^d^{ed by}^em^pl^oy^ee^Oⁿ^l^y^by^em^pl^oy^er.^B^y^an^y^pers^on^on^beh^a^l^f^of^an^elⁱ^gⁱ^b^l^eⁱⁿ^di^vⁱ^du^al^.^B^y^em^ploy^{er or accou}ⁿ^t^owⁿ^e^{r, bu}^{t n}^o^t^bot^h^.
^h^ttp^t^h^r^o^{ugh sa}^l^a^r^y^r^e^d^u^c^tⁱ^oⁿ
^ag^reem^en^t.
^l^N^o^ne^r^e^q^uⁱ^r^e^d^,^t^h^o^{ugh e}^m^p^l^o^y^e^r^s^N^oⁿ^e^requⁱ^r^{ed. Em}^pl^oy^ers^{$2,900 f}^o^r^s^e^l^f-on^l^{y coverage}^an^d^65%^of^t^h^{e dedu}^ctⁱ^b^l^e^f^o^r^s^e^l^f-on^l^y
ⁿ^t^rⁱ^b^u^tioⁿ^u^s^u^a^lly^im^p^o^s^{e a lim}^it.^u^s^u^a^lly^{set th}^eir^coⁿ^t^rⁱ^b^u^tioⁿ^s^{$5,800 f}^o^r^famⁱ^l^y^coverage^{. A}^ccouⁿ^t^coverage^an^{d 75%}^of^t^h^{e dedu}^ctⁱ^b^l^e^f^o^r
^its^b^e^l^o^w^t^h^e^a^nnua^l^d^e^d^u^c^tⁱ^b^l^e^o^f^t^h^e^owⁿ^e^rs^{55 y}^ears^ol^{d or ol}^{der an}^{d n}^o^tⁱⁿ^famⁱ^l^y^coverage.
^accom^p^an^yⁱⁿ^g^h^ealthⁱⁿ^s^u^ran^ce.^Medⁱ^car^{e can}^coⁿ^t^rⁱ^b^u^{te an}^ad^d^itioⁿ^a^l
^{$900 i}ⁿ^2008.
^alif^yⁱⁿ^g^M^o^st^unr^eⁱ^m^b^ur^se^d^m^e^dⁱ^c^a^l^M^o^st^unr^eⁱ^m^b^ur^se^d^m^e^dⁱ^c^a^l^Mos^t^uⁿ^r^eim^b^u^r^s^e^{d m}^e^{dical ex}^pen^s^es^.^Mos^t^uⁿ^r^eim^b^u^r^s^e^{d m}^e^{dical ex}^pen^s^es^.
^pen^s^es^e^x^p^e^nse^s^,^t^h^o^{ugh e}^m^p^l^o^y^e^r^{s m}^a^y^e^x^p^e^nse^s^,^t^h^o^{ugh e}^m^p^l^o^y^e^r^{s m}^a^y^May^b^e^u^s^ed^f^o^r^p^r^em^iu^m^s^f^o^r^loⁿ^g^-^ter^m^May^b^e^u^s^ed^f^o^r^p^r^em^iu^m^s^f^o^r^loⁿ^g^-^ter^m
^im^p^o^s^{e ad}^d^itioⁿ^a^{l lim}^itatioⁿ^s^.^im^p^o^s^{e ad}^d^itioⁿ^a^{l lim}^itatioⁿ^s^.^{care in}^s^u^ran^{ce, C}^O^B^R^A^,^h^ealth^{care in}^s^u^ran^{ce, C}^O^B^R^A^,^an^{d h}^ealth
^M^a^y^no^t^b^e^use^d^fo^r^l^o^ng-t^e^r^m^M^a^y^b^e^use^d^fo^r^l^o^ng-t^e^r^m^c^a^r^eⁱⁿ^s^u^ran^{ce f}^o^{r th}^os^{e receiv}ⁱⁿ^gⁱⁿ^s^u^ran^{ce f}^o^{r th}^os^{e receiv}ⁱⁿ^g
^{care or h}^ealthⁱⁿ^s^u^ran^c^e^an^{d h}^ealthⁱⁿ^s^u^ran^{ce prem}^iu^m^s^{, if}^une^m^p^l^o^y^m^eⁿ^t^c^o^m^p^eⁿ^sa^tⁱ^o^{n und}^e^r^une^m^p^l^o^y^m^eⁿ^t^c^o^m^p^eⁿ^sa^tⁱ^o^{n und}^e^r
^premⁱ^u^m^s^.^th^{e em}^ploy^{er allow}^s^.^f^e^d^e^r^a^{l o}^r^{state law}^,^an^d^h^ealthⁱⁿ^su^r^aⁿ^c^e^f^e^deral^{or s}^t^at^{e l}^a^w^.

⁽^o^th^er^th^an^Medⁱ^g^a^p^p^o^licies)^f^o^r
ⁱⁿ^divⁱ^du^als^w^h^{o are 65 y}^ears^of^ag^{e an}^d
^ol^der.

CRS-5
^H^e^a^l^t^h^Ca^{re F}^l^{exible Spending}^H^e^a^l^t^h^Reim^bursem^e^nt^H^e^a^l^t^h^Sa^vⁱ^ng^{s Acco}^unt^s^M^e^dica^{l Sa}^vⁱ^ng^{s Acco}^unt^s
^Acco^unt^{s (}^F^SA)^Acco^{unts (HRA)}^(HS^A⁾^{(Archer M}^S^A)
^w^a^b^l^e^Noⁿ^e^Noⁿ^e^P^e^r^m^itted^,^su^b^j^{ect to}ⁱⁿ^co^m^e^tax^an^d^P^e^r^m^itted^,^su^b^j^{ect to}ⁱⁿ^co^m^e^tax^an^d
^n-m^e^dⁱ^c^a^l^{10% pen}^a^lty^ex^{cept in}^cas^es^of¹⁵^%^p^eⁿ^a^lty^ex^cep^{t in}^{cases o}^f^dⁱ^sab^ility^,
^draw^als^dⁱ^sab^ility^{, d}^eath^,^o^r^attainⁱⁿ^g^ag^{e 6}⁵^.^death^,^{or attain}ⁱⁿ^g^ag^{e 65.}
^r^r^y^o^ve^r^o^f^B^a^lan^ces^rem^aⁱⁿⁱⁿ^g^{at y}^ear’^s^en^d^P^e^r^m^itte^d^,^a^ltho^{ugh so}^m^e^Fu^{ll am}^ouⁿ^t^m^a^y^{be carried ov}^er^Fu^{ll am}^ouⁿ^t^m^a^y^{be carried ov}^er
^d^fund^s⁽^o^r^up^t^o²^½^m^o^nt^{hs a}^f^t^e^r^y^e^a^r^’s^em^ploy^ers^lim^{it am}^ouⁿ^t^th^{at can}ⁱⁿ^d^e^fⁱⁿ^itely^.ⁱⁿ^d^e^fⁱⁿ^itely^.
^en^{d, i}^f^em^pl^oy^{er perm}ⁱ^t^s^{) are}^{be carried ov}^{er. A}^lim^{ited, on}^e-
^f^o^r^f^eited^to^em^p^l^o^y^er^{. A}^lim^ited^,^tim^{e r}^o^llo^v^e^r^to^an^HSA^is
^oⁿ^e-^tim^{e r}^o^llo^v^e^r^to^an^HSA^is^allo^w^e^d^.
^allo^w^e^d^.
^r^t^ab^ility^B^a^lan^{ces g}^eⁿ^e^r^a^lly^f^o^r^f^eited^at^A^t^di^s^c^retⁱ^oⁿ^of^em^pl^oy^{er, t}^h^ou^g^h^P^o^r^t^ab^le.^P^o^r^tab^l^e.
^t^e^r^mⁱⁿ^a^tⁱ^o^n,^a^l^t^h^o^{ugh CO}^B^R^A^s^u^bj^ect^t^o^C^O^BR^A^provⁱ^sⁱ^oⁿ^s^.
^ex^ten^s^ioⁿ^s^so^m^e^tim^{es ap}^p^l^y^.
ⁱ^{ki/CRS-RS21573}^Ru^{les ar}^{e ex}^p^r^essedⁱⁿ^g^eⁿ^e^r^a^{l ter}^m^{s. No}^{t all d}^e^{tails ar}^{e sh}^o^wⁿ^.

^g/w
^s^.or
^le^ak
^://wiki
^h^ttp

Some Issues
Consumer-Driven Health Care. When the accounts discussed in this report are
paired with high deductible insurance, they become what some call “consumer driven
health plans” (CDHP).⁷ One objective of CDHPs is to allow owners to choose health care
providers and services themselves, not constrained by managed care restrictions. Another
is to give owners a financial incentive to save for future health care expenses in exchange
for accepting the greater risk of a higher insurance deductible. In theory, CDHPs will
slow health care spending and encourage cost-effective care. The extent to which these
objectives will be borne out is not clear, largely because the two accounts most likely to
be effective in these respects, HRAs and HSAs, are still too new to permit adequate
assessment. Much depends on how high the insurance deductibles are, how much money
is put into the accounts and by whom, whether accounts are used to pay for expenditures
other than health care (when allowed), and whether people with accounts can make
informed choices. Additional key questions are how much competition there is among
health care providers and whether prices for health care are or can be transparent.
Equity. The tax savings associated with tax-advantaged health care accounts
depend on the taxpayers’ marginal tax rates; for federal income taxes alone, these vary
from 10% for married couples filing joint returns who have taxable incomes not
exceeding $16,050 up to 35% for married couples filing joint returns who have taxable
incomes over $357,700. (These figures are for the 2008 tax year; other figures apply to
taxpayers with different filing status.) As a consequence, the accounts discussed in this
report are more attractive for higher-income taxpayers; indeed, some consider HSAs more
a vehicle for building retirement income than paying for health care. Critics of these
accounts argue that it is unfair for public health care subsidies (the forgone tax revenue)
to flow disproportionately to higher income taxpayers, particularly since they generally
have more resources to spend on health care in the first place. However, if the accounts
are paired with high deductible insurance, it might be argued that the tax savings are
appropriate for taking on more greater financial risk and using less health care (to the
extent this actually occurs). The latter arguments do not apply to FSAs when taxpayers
do not have high deductible insurance; these accounts subsidize first-dollar payments for
health care and may increase health care spending. As FSAs are available only through
employer plans, they likely appear inequitable to taxpayers who cannot have them.
Targeted Savings Accounts. Current law provides multiple tax-advantaged
savings accounts for education and retirement, as well as health care. It may be simpler
and more effective to have fewer accounts that would be available for a variety of
expenses, perhaps as President Bush once proposed. The President’s Advisory Panel on
Federal Tax Reform recommended in 2005 that MSAs, HSAs, and FSAs be replaced by
new Save for Family accounts that could be used for health care and education expenses;
these would have $10,000 annual contribution limits. The President’s FY2009 budget
would eliminate FSAs and HRAs as a consequence of replacing the exclusion for
employer-paid coverage with a new standard deduction for health insurance.

⁷ HSA and MSA plans require high deductible insurance when contributions are made, though
owners can retain accounts after switching to plans with lower deductibles. There is no legal
requirement for HRAs to be associated with high deductible coverage, though they usually are.
FSAs do not require high deductible insurance.