What is a Health Reimbursement Account?
Health Reimbursement Accounts (HRAs) are health care plans paid for by an employer to reimburse the medical expenses of its employees, their spouses, and dependents. HRAs are designed to give employees more choice and greater control over their health care coverage.
Health Reimbursement Accounts are funded solely by the employer, and cannot be funded through employee salary deductions. The employer sets the parameters for the Health Reimbursement Accounts, and unused dollars remain with the employer - they do not follow the employee to new employment.
Health Reimbursement Accounts vs Other Tax-Favored Health Care Plans
Health Reimbursement Accounts have aspects that make them different from other tax-favored health plans such as Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs). For example, under a Health Reimbursement Account, an unused balance can be carried over to the following year, so the "use it or lose it" aspect of a Flexible Spending Account does not apply. An HRA provides reimbursement up to a maximum dollar amount for a coverage period, and any unused portion of that maximum amount can be carried forward to increase the maximum reimbursement amount in subsequent coverage periods. A Health Reimbursement Account can also reimburse employees for out-of-pocket health insurance costs, which is not the case under an FSA. According to guidance from the U.S. Treasury Department and the Internal Revenue Service (IRS), Health Reimbursement Accounts can allow former employees, including retirees, to continue to have access to unused reimbursements.
Under a Flexible Spending Account, the maximum amount of reimbursement must be available at all times during the coverage period. This is not the case with a Health Reimbursement Account. And, there is no mandatory 12-month coverage period for an HRA. Also, the requirement that reimbursed expenses must have been incurred during the coverage period does not apply to HRAs. A medical expense incurred in one period can be reimbursed in a subsequent period, provided the person was covered under the HRA when the claim occurred. But a medical expense incurred before the HRA was in existence, or before the employee was enrolled in the HRA, cannot be reimbursed.
Taxability of Health Reimbursement Accounts
Medical benefits paid by Health Reimbursement Accounts that meet certain requirements are not taxable to the employees. The basic requirements are that the account must be funded solely by the employer, as mentioned above, and only substantiated medical expenses can be reimbursed. An HRA does not qualify for exclusion of benefits from income tax if an employee has the option of receiving cash or some other taxable or non-taxable benefit other than the reimbursement of medical care expenses.
If any other type of payments or benefits are provided, all the payments from the arrangement, including medical reimbursements, would become taxable. For example, if an Health Reimbursement Account pays a death benefit without regard to medical expenses, none of the amounts paid under the arrangement would be considered medical expense reimbursements exempt from tax. If an employee receives a bonus, or severance pay related to the maximum reimbursement amount remaining in a Health Reimbursement Account upon retirement or termination of employment, none of the benefits from the account would qualify for tax exclusion.
Qualified medical expenses are those specified in the Health Reimbursement Account plan, and are generally those that would qualify for the itemized deduction for medical and dental expenses on Schedule A of Form 1040.
Coverage Under an Health Reimbursement Account
Current employees, former employees including retirees, their spouses and dependents, and the spouses and dependents of deceased employees, can be covered under a Health Reimbursement Account. Former employees and retirees can continue to receive medical reimbursements under an HRA even if they do not elect COBRA coverage. The HRA can have a provision allowing former employees or retirees to be reimbursed only up to the unused reimbursement amount remaining at the time of retirement or termination, and the HRA can also stipulate that reimbursements after retirement or termination are reduced by the administrative costs of continuing the coverage.
Health Reimbursement Accounts are not Cafeteria Plans
Employer contributions to a Health Reimbursement Account cannot be attributable to a salary reduction plan, such as an FSA. An HRA can be provided as part of a cafeteria plan and still qualify for tax exemption of medical expense reimbursements. For example, an employer can offer employees a choice between an HRA and coverage under a Health Maintenance Organization (HMO), and the HRA benefits would still be excluded from tax, provided the employees do not have the option of receiving cash or other taxable benefits.
But, if the medical expense reimbursement arrangement interacts with other cafeteria plans in such a way that employees can use salary deductions to indirectly fund the account, then that arrangement would not qualify for exemption from tax as an HRA.
Health Reimbursement Account Ordering Rules
If a medical expense is covered under both a Health Reimbursement Account and a Flexible Spending Account, amounts available under the Health Reimbursement Account must be used up before reimbursement can be made from the FSA (unless the plan documents state otherwise). This rule is not violated if a medical expense not reimbursable under an HRA is paid from an FSA.