What You Need to Know About Medical Reimbursement Plans

Medical reimbursement plans were created to help employees pay for out-of-pocket medical expenses. Typically, these plans are used in conjunction with a group health insurance plan, but employers may be able to offer a medical reimbursement plan to part-time employees or employees who simply choose not to participate in the company’s medical insurance plan.

Here’s what you need to know about the four most common medical reimbursement plans on the market today.

Health Savings Accounts

Health savings accounts (HSAs) are savings accounts individuals use to pay for out-of-pocket qualified medical expenses for themselves, their spouse and their dependents. Only individuals with high-deductible health plans can contribute to an HSA.

To fund their HSA, the employee transfers a portion of their pretax earnings (typically via payroll deduction) into their account. Those funds grow tax free, and if they are used to pay for qualified medical expenses, the employee will never pay income tax on the principal balance or earnings.

People who have HSAs find them beneficial for the following reasons:

They are not “use it or lose it” accounts. HSAs can carry a balance from year to year. This helps employees save for large medical expenses, like the birth of a child or a spouse’s unexpected trip to the emergency room.

They can be used to save for retirement. HSAs can help individuals save for the medical care they may need in retirement. For example, HSAs can pay for COBRA coverage, Medicare premiums and long-term care expenses.

HSA owners will never need to forfeit their funds. HSA funds will always belong to the account owner. If they move jobs or become unemployed, they do not need to forfeit their balance. If they switch to a low-deductible plan, they can no longer contribute to their account, but they can continue to use those funds to pay for qualified medical expenses.

Employers and third parties can contribute to someone else’s HSA. As a perk of employment, some employers contribute to their employees’ HSAs. A family member or friend can also contribute to an individual’s HSA, but (1) they will need to use after-tax dollars to make those contributions, (2) their donations will be subject to gift taxes and (3) they cannot take a deduction. The HSA owner is the only one who can deduct HSA contributions, even if those contributions were made by someone else.

Employees can open an HSA even if their employer doesn’t offer one. If their employers don’t sponsor an HSA, employees can open their own HSA with a third-party provider.

In 2022, the HSA contribution limits are $3,650 for individual health plans and $7,300 for family plans, and participants ages 55 and older can make additional $1,000 catch-up contributions. Just keep in mind that all contributions, whether made by the account owner, employer, family member or friend, count toward these limits.

Flexible Spending Accounts

Like HSAs, flexible spending accounts (FSAs) are individual savings accounts funded with pretax dollars that individuals use to pay for out-of-pocket medical expenses. There are three main differences:

1. FSAs are owned by the employer. Employees have the right to use the funds in their account, but the account itself belongs to their employer.
2. FSA funding is determined at the beginning of the year and cannot be changed. At the beginning of the plan year or after a qualifying event like a marriage, divorce or adoption, the employee estimates their medical expenses for the year and determines how much they want to contribute to their account. Throughout the year, these funds are transferred into their FSA via payroll deductions, which the employee can pull from when they incur qualifying medical expenses.
3. FSA funds expire. Unused FSA funds are forfeited to the employer (the plan owner) at the end of the year. Employers can elect to give a 2.5-month grace period or allow the individual to carry over up to $570* each year, but the default option is that funds expire on December 31.

*The Consolidated Appropriations Act allowed 100% of unused amounts from the 2021 plan year to roll over into the 2022 plan year.

FSAs are beneficial for some of the following reasons:

They can be used with any health care plan. FSAs can be used with high- or low- deductible health care plans or with no health care plans at all.

They’re flexible. Employers can offer health care FSAs, dependent care FSAs and/or limited use FSAs. Limited use FSAs are often used to pay for dental or vision care only to help supplement a group health care plan that does not have dental or vision coverage.

They can be used in conjunction with an HSA. Individuals with HSAs typically cannot also have health care FSAs, but they may be able to have a limited purpose FSA if their employer offers it.

In 2022, employees can elect up to $2,850 in FSA salary reductions. Employers can also contribute to their employees’ FSAs, subject to certain limits, but those limits will not affect how much an employee can contribute to their own plan.

Below is a graph that compares HSAs with FSAs.

Health Reimbursement Arrangements

Health reimbursement arrangements (HRAs) are plans that reimburse employees for eligible medical expenses, potentially even including the cost of obtaining outside insurance coverage. But unlike HSAs or FSAs, HRAs are not funded by the employee; they are nontaxable fringe benefits provided by the employer.

There are a few different types of HRAs:

• Integrated (or traditional) HRAs
• Individual coverage HRAs
• Qualified small employer HRAs
• Excepted benefit HRAs

Each of these plans is a bit different, but in general, here’s how they work:

The employer determines how much they are willing to spend on medical care reimbursements for each employee. As employees request reimbursement for qualified out-of-pocket health care expenses, the employer uses their HRA to reimburse employees up to those predetermined allowances. We went into greater depth of HRAs here, but as a summary, here are a few reasons why a business might want to establish an HRA.

HRAs offer tax-free benefits. Businesses hoping to boost their benefits packages can do so with HRAs, tax free. HRA costs are deductible to the business and nontaxable to employees.

HRAs are low risk. Because HRA funds aren’t paid out until expenses are approved, the arrangements are at low risk for fraud or misuse.

HRAs cost employees nothing. An HRA is a cost-free benefit to employees. This means HRAs can be great tools to recruit new talent.

HRAs are flexible. In recent years, legislation has made HRAs more accessible and flexible than ever before. Businesses with health care plans can use HRAs to make their costs more affordable. Businesses without health care plans can use HRAs to help employees purchase outside insurance. HRAs can even be used differently for different classes of employees.

Medical Expense Reimbursement Plans (MERP)

A medical expense reimbursement plan (MERP) is similar to an HRA in that businesses use them to reimburse employees for out-of-pocket health care costs. But MERPs have one leg up on HRAs: more than one type of MERP can be paired with a single insurance plan.

MERPs are used to help customize an insurance plan. Businesses will select one type of plan from their insurance carrier and then use MERPs to build different coverage options for employees. For example, one MERP might be a no-fuss, high-deductible plan for individuals with low health care risks, while another MERP might supplement the basic insurance plan by covering vision, dental, chiropractic care, occupational therapy and other IRS-approved wellness costs.

Even though the underlying insurance plan is the same, employees can select the MERP that offers the coverage they need. HRAs cannot be used the same way; only one HRA can be used to supplement a single insurance plan to customize insurance for employees.

MERPs are beneficial for the following reasons:

MERPs are customizable. MERPs effectively help businesses customize their insurance offerings. They can make a single health insurance plan appeal to employees with vastly different coverage needs.

MERPs allow for tax-free employee contributions. Because employees can select the amount of coverage they want, out-of-pocket health care costs are potentially shared between the employer and the employee. Employee contributions are tax free, and MERP payments are deductible to the employer.

MERPs are not tied to a single insurance carrier. Typically, MERPs are used to supplement insurance plans. A third-party administrator (TPA) coordinates the collaboration between the MERP and the insurance carrier. Though TPAs will increase administrative costs of the insurance plan, in exchange, employers can change insurance carriers (or select a different plan from the same insurance carrier) without having to establish new MERPs. This helps keep costs low and shields employees from year-to-year changes in insurance coverage.

Insurance Decisions Matter

Health insurance can feel like a minefield. There are so many options to choose from, and with all these different types of medical reimbursement plans on the table, there are even more ways to customize insurance for employees. Businesses should consider their employees’ needs and the costs, but they should also talk to their tax advisor to ensure they’re selecting a plan that will benefit the business.