Open enrollment season for health insurance brings attention to Flexible Spending Accounts and Health Savings Accounts. I’m a huge fan of the latter. Let’s look at both.
First Came FSAs
Flexible Spending Accounts have been around since the 1970s. Employers establish FSAs for their employees, and the account allows workers to contribute a portion of pre-tax earnings to pay for qualified health care costs. Many employers also offer a separate FSA for dependent care expenses, such as day care.
The tax advantages of FSAs serve as one of the biggest benefits to employees. Because you contribute earnings before they’re taxed, you lower your annual tax liability. Your contribution limits are $2,500 for a medical FSA and $5,000 for an FSA used for dependent care (as long as you don’t file taxes married filing separately, then the limit is $2,500).
Different Rules for HSAs
Health Savings Accounts were created to help ease the financial burden of rising health care costs.
Like FSAs, the money you contribute to the fund is pre-tax (which again reduces your overall tax burden). HSAs allow you to spend money on qualified health expenses if you have a high-deductible health plan. You can also pay for medical costs not covered at all by your insurance (such as Lasik eye surgery like I had).
You can contribute up to $3,300 to an HSA ($3,350 for 2015), and a family can contribute $6,550 ($6,650 for 2015). Like a Flexible Spending Account, the HSA limit does not vary based on your tax bracket. However, there is a $1,000 “catch up” contribution for those over 55.
However, unlike an FSA, anyone can set up an HSA — you don’t need to get through your employer (although that is an option). To qualify, you must be under 65 and have only high-deductible health insurance.
Pros and Cons for Flexible Spending Accounts
FSAs have no restrictions on what type of health insurance you have. You don’t even have to have health insurance.
Your FSA is set up and owned by your employer, which means you cannot take it with you if you leave, lose or retire from your job.
With an FSA, you have to use or lose the money you contribute by the end of the year (you can carry over $500 into March of the following year). If you are a careful planner, this will be easy for you, but last year, 20 percent of people with FSAs left $500 or more on the table. Don’t make this mistake! (Buy yourself a new pair of glasses!)
Before investing in an FSA, have a reasonable estimate of upcoming medical expenses for you and your family. That way you can use all of that money and not be stuck with extra money at the end of the year you have to use up quickly.
Pros and Cons for Health Savings Accounts
You own your Health Savings Account. You can take it with you when you leave your employer and either cash it out (although don’t do that — because you’ll likely incur a penalty) or roll it over into a new plan.
You can also invest the money in your HSA, and the value rolls over from year to year. Some plans only invest your money once you’ve reached a minimum, but others allow you to invest immediately. If invest the money in your HSA to use for future health care costs, make sure you have enough to cover your deductible so that you don’t have to sell investments quickly to access the funds.
HSAs are limited to those with high-deductible health plans. An individual HDHP deductible can range from $1,250 to $6,350. For families, the minimum deductible is $2,500 and the maximum is $12,700. Make sure you can cover your deductible, although you can use your HSA contribution to pay for out-of-pocket health-care costs, prescriptions and other medical expenses.
Which is Right for You?
Married couples with a young child and a lot of doctor’s visits may lean toward an FSA for co-pays. A lower deductible PPO or HMO plan may also benefit this family more than a high-deductible health plan. In addition, the Dependent Care FSA offers a huge tax benefit.
A healthy single person, on the other hand, may decide the HSA is a better deal, which is why I encourage many of my Gen Y clients to strongly consider this option. This account is good for those who can’t predict how much (or how little) they may use a medical savings account.
With an HSA, you can continue to invest and make money, which you can then use, without a tax penalty, when you get to your retirement years. (Some people choose to think of an HSA like an additional individual retirement account). An FSA can give you peace of mind to help you with child care or medical care expenses right now.
You can contribute to both — but be careful. You can technically have an HSA for medical expenses if you have a high-deductible plan and an FSA for dental and vision costs; however, I would generally recommend that you just stick to one or the other.