While there is no shortage of strategies to consider, Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) are two vehicles that can help individuals pay for their medical costs.
With annual health care expenses coming in at more than $10,000 per person on average, understanding these options is crucial for financial as well as physical wellness.
HSAs and FSAs were introduced more recently, but their utilization has greatly increased in recent years. To qualify for an HSA, an individual must have a high-deductible health plan (HDHP) with a deductible of at least $1,350 for an individual or $2,700 for a family. He or she cannot be claimed as a dependent on someone else’s tax return, or be eligible for Medicare (i.e., aged 65+ or receiving Social Security Disability Insurance).
If the above criteria is met, HSAs allow participants to contribute, save for, and pay for medical expenses tax-free. An HSA is portable and dollars roll over from year-to-year, so people are able to take the money with them even if they leave their job. HSA funds can be used for medical expenses tax-free at any time, and after age 65, they can also be used for general retirement expenses (although they are taxed at withdrawal, much like an IRA). HSAs are also investable, so they truly can and should be seen as an additional savings tool for retirement.
HSAs found themselves in the spotlight in 2017, since the GOP’s proposed healthcare reform legislation would have made meaningful changes to contribution limits. Despite talk of these dramatic increases, limits are only up modestly for 2018. The maximum HSA contribution is up $50 to $3,450 per year for an individual, and up $150 to $6,900 per year for families. Those who are 55 or older are eligible to make an additional catch-up contribution of $1,000/year.
Flexible Spending Accounts (FSAs) are often confused with HSAs, which is not surprising given some similarities between the two vehicles. Like an HSA, an FSA allows individuals to set money aside for qualified health care expenses. FSAs also come with tax benefits – contributions are pre-tax and distributions are untaxed.
Unlike HSAs, an FSA has no eligibility requirements. Accounts are tied to an employer, so participants lose their FSA with a job change. As mentioned, HSA balances can be carried from year-to-year and even invested, but an FSA’s balance is “use it or lose it” – meaning dollars must be used by the end of the calendar year. Contribution amounts can only be adjusted at open enrollment or with changes in employment/family status, and they are capped at $2,650 for 2018, up $50 from last year.
Generally speaking, an HSA is a great long-term savings tool, whereas FSAs make sense for paying anticipated healthcare expenses over the course of a single year. If a person qualifies for an HSA, it is often more favorable than an FSA due to higher contribution limits, more generous rollover/portability, and the ability for long-term investment. Depending on their needs, employees could maximize tax savings by using an HSA in conjunction with a limited purpose FSA – to be used for dental, vision, or other eligible non-medical expenses. Dependent care FSAs are also available with a limit of $5,000/year.