Health Savings Accounts: Is a FSA Or an HSA Right for You?

Saving for medical bills isn’t nearly as fun as putting money aside for a trip to Disney World or a new car, but having a nest egg ready for an emergency – or even some unexpected prescriptions – has real advantages, especially when it’s socked away tax-free.

The rising costs of health care are driving many workers, especially those who are younger and healthy, to choose lower-cost health insurance policies with high deductibles and copays during the annual open enrollment period at their workplace.  However, if the policyholder faces an unexpected change of health or suffers an accident, the costs can be staggering. Both options are restricted to those with commercially purchased insurance plans.

Two federal tax-code provisions – the Health Savings Account (HSA) and Flexible Spending Account (FSA) help people worried about medical expenses not covered under their insurance policies.

How Health Savings Accounts Work

The HSA is designed specifically for high-deductible policies, obtained either through your job or on your own. Such policies have minimum deductibles of $1,300 for an individual or $2,600 for a family.

In 2017, qualifying policy holders can make a $3,400 pre-deductible contribution to an HSA, with the family limit capped at $6,750. Those 55 and older can make an additional $1,000 catch-up contribution annually to a plan. HSA funds can be invested and the money in the accounts grows tax-tree until it is withdrawn for a permitted medical expense. Even if the money is withheld from your paycheck, it is yours to invest and spend subject to tax-code rules.

HSAs offer a three distinct tax advantages: contributions to your account are pre-tax or tax-deductible; your interest or investment income grows tax free; and withdrawals for medical expenses are tax free.

To get started, you need to open and make a deposit to a qualified account. Remember to name a beneficiary. If you should die and no beneficiary is named, the account could be subject to probate.

Money in HSAs is tax exempt if it remains in a designated account and is only used to cover qualified medical expenses. If you are you are younger than 65 and withdraw money for non-qualified medical expenses or other unpermitted purpose, you’ll pay a 20 percent penalty as well as income tax on the withdrawn amount.

One attractive feature of an HSA is that you can keep the money indefinitely. That is the primary difference it has with the FSA.

How Flexible Spending Accounts Work

FSAs are available to workers who get insurance coverage through their employer. Like HSAs, FSA money can be used for qualified medical expenses and isn’t taxed, but there are significant differences. FSA contributions are made through payroll deductions and may or may not come with an employer contribution.

Most importantly, FSA funds generally must be spent in the tax year they were earned. Some employers allow workers to spend up to $500 before March 15 in the following year, but otherwise unspent contributions are lost.

During 2017, FSA contributions are capped at $2,600.  At the beginning of the year, when you make withholding elections, you’ll be asked how much to designate. You’ll be able to spend up to the annual tax-free maximum, even before the money is withheld from your paycheck, and if you lose your job or quit before the end of the year, you don’t need to pay back FSA funds to your employer.

While HSA contributions grow for as long as they’re held, the requirement that FSA money be spent during the tax year forces you to estimate what you’ll need. Many people review their medical expenses and household budget from the past several years to arrive at an amount.

But mistakes happen. If you had the maximum amount withheld in anticipation of having surgery, then learned the operation wasn’t necessary, you’ll need to find another qualified way to spend the funds or they’ll be lost.

Ways to Maximize Your FSA Claims

• Consider qualified dental work, including procedures like X-rays, fluoride treatments, extractions and teeth alignment, are covered.
• Contact lenses needed to correct vision are included. So are eye exams and glasses.
• Smoke-cessation programs are on the list if you need help quitting.
• Acupuncture is permitted (so long as you’re OK with needles).
• Medical prescriptions are covered. These include over-the-counter drugs and supplies if you have a doctor’s prescription for them. If you need refills near the end of the year, get them immediately and use your FSA money.

Health savings accounts should be part of your overall emergency savings plan, which should include savings for health emergencies, review of your insurance policies and saving for other unexpected life events.