Although medical insurance is a necessity, the cost of coverage can be hard to swallow. Fortunately, the IRS has allowed for some workplace savings options to help ease the burden of out-of-pocket expenses: flexible savings accounts (FSA) and health savings accounts (HSA).
Each savings vehicle offers a host of benefits, so size them up alongside your situation to see if one—or both, in limited form —can work for you.
FSAs and HSAs allow you to set aside a portion of your paycheck before taxes are withdrawn, making your tax bill a little lower. The funds are deposited into an account from which you can make tax-free withdrawals to pay eligible medical expenses, such as copays, deductibles and coinsurance as well as qualified medical equipment, procedures or prescriptions.
Neither account requires your participation or contribution — each is voluntary. Likewise, your employer may choose to contribute as an added benefit, but it is not required. And the IRS limits contributions to both types of accounts, typically adjusting amounts annually for inflation.
An FSA is only available through an employer; if you’re self-employed, this is not an option (skip ahead to read about HSAs). You can contribute to an FSA with any type of insurance plan, even a high-deductible plan.
At enrollment, you decide how much to set aside for the year, and equal contributions are withdrawn from each paycheck. Your funds can’t be invested, nor will they earn any interest. On the plus side, you usually don’t need to pay fees or build up your account balance before using it — the full annual election is available immediately.
The challenge here is to estimate your out-of-pocket expenses for the year ahead, as the FSA is often referred to as a “use it or lose it” benefit. The account belongs to the employer, so any of your unused funds at the end of the year may be forfeited. Some employers will offer a grace period, giving you until March 15 of the following year to spend remaining dollars, or will allow you to carry over up to $500.
Keep in mind that your elections may only be revised with a change in family status, such as the birth of a child. If you change jobs, the account doesn’t transition with you. However, if you have depleted your election before fully funding it, the assets do not need to be repaid if you and your employer part ways.
HSAs are available to individuals who participate in high-deductible health plans, including those who are self-employed. Each year, the IRS updates criteria for what constitutes a high-deductible plan based on individual and family deductibles and out-of-pocket expenses.
At enrollment time you can set up an automatic recurring contribution amount to your HSA. Contributions are 100% tax deductible (up to the IRS specified limit). Contributions can be made by the individual, an authorized signer or a non-authorized signer. Employers often contribute to an individual HSA as part of an employee benefit program.
An HSA is owned by you, which means that there is no clock ticking on the funds, and they follow you no matter where (or if) you work. Any funds remaining in the account at year-end rollover into the next, and they do not count toward the following year’s contribution limit. As a result, you have an opportunity to build a sizeable balance.
HSAs earn interest allowing your balances to grow as you build a savings for future health care costs. A small fee may be associated with your HSA, but any earnings within the account are not taxed, providing one of three attractive tax benefits – the others being the pre-tax contributions and tax-free withdrawals for eligible expenses.
If you’re looking ahead to retirement, an HSA can be tapped for qualified medical expenses in those golden years. You can always access the assets sooner for non-qualified expenses, but be prepared to pay taxes on the withdrawals as well as a 20 percent penalty if they occur before age 65.
Which is right for you?
When deciding to participate in a FSA or HSA, consider any anticipated healthcare needs for yourself – or any dependents – in the coming year and what type of medical, dental and vision coverage will apply. Funds in either account can help bridge any gaps.
Moreover, both accounts can offer peace of mind in knowing that you have tax-free savings set aside for the unexpected. Just be prepared to keep track of any spending for tax purposes and to ensure funds are used, not forfeited.
And be sure to raise any questions with your HR or benefits representative so you can feel awesome about your decision.