Health savings accounts (HSAs) and flexible spending accounts (FSAs) are two tax-advantaged vehicles that can help employees pay for their medical costs. With annual health care expenses reaching more than $10,000 per person on average, understanding these options is important for financial as well as physical wellness.
The use of HSAs and FSAs has risen dramatically in recent years. To qualify for an HSA, a participant 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., age 65 and over or receiving Social Security Disability Insurance).
For employees who meet these criteria, HSAs allow them to save and pay for medical expenses tax-free. An HSA is portable and unused contributions roll over from year-to-year, so employees retain the money for their use even if they leave their job. HSA funds can be used for medical expenses at any time, and once the account holder reaches age 65, they can also be used to pay for general retirement expenses, although in this case they are taxed at withdrawal, much like an IRA. HAS funds are also investable, so they can and should be used as an additional savings tool for retirement.
Despite much talk in Washington about dramatically increasing the amounts that individuals can contribute to these accounts, in the end HSA contribution limits only rose modestly for 2018. The maximum annual HSA contribution increased $50 to $3,450 for an individual and $150 to $6,900 for families. Those who are 55 or older are eligible to make additional catch-up contributions of $1,000 per year.
Flexible Spending Accounts are often confused with HSAs, which is not surprising given the similarities between the two vehicles. Like an HSA, an FSA allows employees to set money aside for qualified health care expenses on a tax-free basis; contributions are pre-tax and distributions are untaxed.
‘Use it or lose it’
Unlike HSAs, FSAs have no eligibility requirements, but accounts are tied to an employer, so participants lose their FSA with a job change. As mentioned, HSA balances can be carried over from year-to-year and even invested, but an FSA’s balance is “use it or lose it”—meaning the dollars contributed are forfeited if they are not used by the end of the calendar year. Contribution amounts can only be adjusted during open enrollment or with changes in an individual’s employment or family status, and they are capped at $2,650 for 2018, up $50 from 2017.
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 an employee qualifies for an HSA, it has more advantages than an FSA due to the higher contribution limits, more generous rollover and portability features and opportunities for long-term investment. Depending on their needs, employees could maximize tax savings by using an HSA in conjunction with a limited purpose FSA – the funds from which can be used for dental, vision, or other eligible non-medical expenses. Dependent care FSAs are also available with a contribution limit of $5,000 per year.
Given the significant long-term tax and savings benefits, employees should be encouraged to take full advantage of these savings vehicles.
