Having a health insurance plan does not mean that all medical expenses are covered. Health savings accounts (HSA) and flexible savings accounts (FSA) are designed to help consumers budget for deductibles, co-pays, prescription costs, out-of-pocket costs, and other unexpected medical expenses. In addition to helping consumers manage planned and unexpected medical expense, both HSAs and FSAs lower an individual’s taxable income, which in turn reduces the amount of annual taxes paid to the IRS.
Health Savings Accounts (HSA)
A health savings account (HSA) is a special account available for consumers who have a high-deductible health care plan (HDHP), which is a plan with an annual deductible of at least $1300 for individuals and $2600 for families. Tax deductible contributions are made to the account. Employers can also make contributions. The funds in the account are invested and grow tax-free. There is a limit to the annual contribution amount. In 2018, the limit is $3450 for individuals or $6900 for families. Funds in the account can only be used for eligible health care expenses (expenses primarily associated with medical, dental, and vision). There is no deadline for making a withdrawal from the account so funds are able to accumulate year to year.
HSA Pros
- An HDHP has high out-of-pocket cost (annual deductible of at least $1300 for individuals and $2600 for families). The HSA can help to make the deductible more affordable and easier to manage.
- HSAs are available with group health plans and private health plans. A bank account is set up and owned by you no matter where you are employed.
- Pre-tax dollars are contributed to the account which will reduce your taxable income. Withdrawals for eligible expenses are not taxed.
- Interest is earned tax-free on the funds in the account. When selecting the investment, it is recommended to consider lower risk investments since it is difficult to determine when funds will be needed to pay expenses.
- Documentation of proof of expenses is not required, although it is a good policy to keep all receipts and records of expenditures.
- On a monthly basis, you can change your contribution amount.
HSA Cons
- HSAs can only be used with a high-deductible plan. Not every HDHP is HSA compatible; check the specifics of the plan before enrolling in the health insurance.
- Funds cannot be used to pay health insurance premiums.
- If funds are withdrawn for non-medical use before age 65 a penalty is assessed (check plan specifics for penalty amount).
- Investment portions involve the same risks as any other investment account.
- You only have access to the funds that have been deposited in the account even if you have planned contributions throughout the year. For example, if you have an expense that exceeds the balance of the account, you will not be reimbursed or able to pay the full amount from the account at that time. If you pay the amount due out-of-pocket, you will be able to be reimbursed later when the funds are available.
Flexible Spending Accounts (FSA)
A flexible spending account (FSA) is an employer-sponsored account that allows employees to either pay or be reimbursed for eligible medical and/or dependent care expenses. The employee contributes pre-tax dollars to the FSA. Funds in a dependent care FSA can be used for the care of dependents under the age of 13 or for a dependent who is physically or mentally unable to care for themselves who lives in the insured’s home. Qualified, unreimbursed out-of-pocket expenses for health care can be paid with medical FSA funds (medical, dental, and vision expenses). When making the election for the contribution amount, separate amounts are designated for medical FSA and dependent care FSA. The annual contribution limit for 2018 is $2650 for medical FSA and $5000 for dependent care FSA.
FSA Pros
- Many employers offer debit cards that withdraw funds directly from the account. For example, prescription costs or co-pays can be directly paid with the debit card to eliminate the need for reimbursement.
- Pre-tax dollars are contributed to the account which reduces taxable income.
- Health care and dependent care expenses can be more easily budgeted throughout the year.
- The insured can have both an HSA and an FSA. This is a benefit if the insured has dependent care expenses because these expenses are not allowable with an HSA.
- You have access to the entire planned contribution amount at any time during the year even if the funds have not been deducted from your paycheck. For example, if you have an expense that exceeds the balance of the account, you can be reimbursed or are able to pay the full amount from the account at that time.
FSA Cons
- FSAs do have a “use it or lose it” rule. Annual contributions that are not used during the designated time period (one year plus a 2 ½ month grace period) are forfeited. To avoid forfeiting funds, estimate your dependent care and medical expenses before you designate your annual contribution.
- FSAs are only available with group health plans so there may be limitations set by the employer. For example, the employer can set a lower contribution limit than is designated by the IRS.
- An FSA is an account set up and owned by the employer so does not move with you if you change employers.
- Your employer or FSA provider may ask you to provide documentation (receipt) for approval of an expense.
- You can only change the selected contribution amount during your employer’s annual enrollment period unless you experience certain qualifying events such as death, marriage, or the birth of a child.
In Summary
If you have access to HSAs or FSAs through your employer’s group health insurance or your private insurance (HSA only), take advantage of the opportunity for tax savings. When deciding whether an HSA or an FSA is a better option for you, consider your average annual medical expenses, the type of expenses you have, and over-all budget needs.
