Let’s tackle the second question first. If you’re eligible, you should use an FSA or an HSA because they can help you pay unexpected medical bills – and can help you save on your taxes.
What’s not to like?
The first question – defining FSAs and HSAs – is a bit more complicated, which is why people are often confused by the difference between FSAs (Flexible Spending Accounts) and HSAs (Health Savings Accounts).
The two are quite similar in that they’re special, personal savings accounts you can use to pay “qualified” medical bills not covered by insurance. But FSAs and HSAs differ in the way they’re set up, who’s eligible to have them, and how long the money in them can be used.
Here’s a closer look.
Similarities Between FSAs and HSAs
The most important advantage of FSAs and HSAs is a big one.
The money you put into a health savings account is deducted from your paycheck before any taxes are taken out.
Let’s look at an example. If you’re normally paid $2000 per pay period, and you want to contribute $200 of your paycheck into your health savings account, your contribution comes “off the top” before any taxes. That means you only have to pay taxes on $1800 for that pay period, with the extra $200 put into your account tax-free. No taxes are due when the money goes in, and none are due when the money is spent. (You can also contribute your own money to an HSA, and deduct the contributions from your taxes.) That’s a great deal, any way you look at it.
The other big advantage is that you can use the money any way you choose as long as it’s for acceptable medical expenses. There’s a long and detailed list of what qualifies, but in a nutshell you can pay for doctor’s bills (including insurance deductibles and copayments) and prescriptions, plus many medical supplies and equipment. Items like over-the-counter medications or gym memberships aren’t eligible, nor are that new flat-screen TV or Mercedes that you’re sure will greatly help with your depression. Nice try, though!
FSAs: The Specifics
To use a Flexible Savings Account, your employer must offer the option as an employee benefit. You can’t have an FSA otherwise, and you can’t set one up for yourself if you’re self-employed. You can only choose how much you want to contribute at the start of each year, unless your family status changes during the year (due to marriage or divorce, for example).
There’s a limit to how much you can contribute each year; in 2017, the limit was $2600.
Here are two crucial things to know. First, the account belongs to the employer, not the employee. If you leave the company you’ll lose the money in your FSA (and the employer keeps it), so use it up if you plan to quit. FSAs also are year-to-year accounts so you’ll normally lose whatever’s in your account when a new year starts, although some employers let you roll over up to $500 into the next year, and some give you a 2½ month grace period before the money vanishes.
HSAs: The Specifics
To be eligible for an HSA you must have what’s called a “high deductible health plan” (HDHP), meaning that your deductible must be at least $1300 ($6750 for family coverage) and your out-of-pocket maximum can’t be higher than $6500 ($13,100 for family coverage). If you meet that requirement, you can establish an HSA through your employer (if they offer the option) or via self-employment.
There are also limits to how much you can contribute each year. In 2017 the maximum was $3400 ($6750 family), with an additional $1000 available if you’re over age 55. If you’re extremely lucky, some employers make their own, additional contributions to their employees’ HSA accounts.
What matters most about an HSA: the account belongs to you and not your employer, and the money in the HSA can be rolled over indefinitely, tax-free. That makes it a wonderful additional investment vehicle since any interest accumulates tax free, with taxes only due if the money in the account is used for non-qualified purposes.
A tax-free savings account that’s available for medical expenses and emergencies – for life? Yes, please.