What Is an HSA, FSA and HRA and How Do They Work?

Enacted into federal law in December 2003, Health Savings Accounts (HSA) are tax-advantaged accounts that can be used to pay for eligible medical expenses.See Disclosure ¹ They work solely in coordination with healthcare insurance plans that have high deductibles. Therefore, you must be enrolled in a high-deductible health plan (HDHP) to be eligible for an HSA.

Contributions to an HSA are made with pretax dollars, which reduces your taxable income. And you can roll over the money in the account from one year to the next. Plus, while in the account, that money gains interest tax-free. You can even manage the funds for higher returns. Withdrawals for eligible expenses, such as hospital visits, new eyeglasses, and prescription drugs, are also tax-free, but withdrawals for other purposes are subject to fees.

HSA plans are available to both employees and the self-employed. In either case, you own the account. So, if you switch employers, you can take your plan with you.

Just like an HSA, a Flexible Spending Account (FSA) also allows you to set aside money for qualified medical expenses, such as office visits and health supplies for you and your family. In this case, your contributions must come directly out of your gross pay from your employer, meaning the money you contribute to your FSA is deducted from your paycheck before taxes are taken out. So, it is impossible to have this plan if you are self-employed because you are not the owner of an FSA account; your employer is. Additionally, FSA accounts do not accrue interest, but they do lower your taxable income.

This might have you wondering why anyone would choose an FSA over an HSA. There are two main benefits: a wider choice of health insurance options and the inclusion of childcare. You can choose to set up a Dependent Care FSA (DCFSA), which allows you to make withdrawals for childcare expenses. Also, unlike an HSA, an FSA does not require you to choose a high-deductible health plan. In fact, you do not need to have a health insurance plan at all.

However, keep in mind that there is a limit to the amount of unused funds that you can roll over into the next year. In 2023, employers have one of two options: they can either allow employees to roll over as much as $610 into the following year’s FSA plan, or they can choose to provide an additional 2 and a half months to use the funds.² Another thing to note is that you cannot use FSA funds to pay health insurance premiums. So, you’ll want to be strategic in your budgeting to ensure you use all of it. Many people who have money left in their accounts at the end of the year choose to spend it on FSA/HSA eligible products.

Additionally, you usually have a specific enrollment period for choosing to open an FSA that might only come around once a year. And once you set the amount to be deducted from your paycheck each month, you may not be able to change it after the fact.

Now that you know what an FSA and HSA are and what an HRA entails, you can better decide which one is right for you. For instance, if you are self-employed, an HSA is the only option on the table for you. In making this choice, you will also have to weigh whether a high-deductible health plan is right for you. If you are young and healthy, a high-deductible plan paired with an HSA can be ideal. But if you have a lot of medical expenses every year, you might see better overall savings from a plan with a low deductible and no HSA.

If you are an employee, you could have all three options to choose from. If you want your plan to follow you if you change employers and you are okay with a high deductible health plan, choose an HSA. If you want more insurance options but would still like to save money on taxes and things like kids’ healthcare items or doctor’s visits, choose an FSA or DCFSA — (or both) — and make sure you use up all the money in the account. And if you want to take home your whole paycheck but also want some help with medical expenses, choose the HRA.

1. “Health Savings Accounts.” NCSL.org. National Conference of State Legislatures. August 31, 2020. https://www.ncsl.org/research/health/hsas-health-savings-accounts.

2. “Using a Flexible Spending Account.” HealthCare.gov. U.S. Department of Health and Human Services. Accessed November 28, 2022. https://www.healthcare.gov/have-job-based-coverage/flexible-spending-accounts/.