The Health Savings Account (HSA) may be the most beneficial and yet largely understood employer benefit offered at my employer. People often mistake it for the Flex Spending Account (FSA), believing that any money they put into the HSA will have to be spent by the end of the year. This lack of clarity is preventing people from taking advantage of each account (especially the HSA). Let’s dig in and see what benefits we can get from each.
Health Savings Accounts (HSA)
First, in order to take advantage of the HSA, you must be enrolled in a High Deductible Health Plan (HDHP). These health plans are far more prolific than they used to be, and the HSA can help you save money pre-tax over a long period of time in order to address the costs of a high deductible. In 2017 if you have a family that has a $2600 minimum deductible on your health insurance your insurance would be considered an HDHP. If this applies to you, then I suggest you take advantage of the HSA account because it carries the following benefits.
Not a “Use it or Lose it” Account
With the HSA you can save money over years and years. There is no requirement to use it before the end of the year by binge purchasing Disney Band-aids. The money available in the HSA is the money you (or your employer) have put into it over the entire lifetime of the account. The money is yours and remains yours. You won’t forfeit it at the end of the year like the FSA (more on that later). This also affords you the opportunity for interesting long-term opportunities to grow your HSA passively through investments (more on that later, too.)
Dental, Vision, and Other Qualified Medical Expenses
Your HSA dollars can go to a lot of other places than simply the doctor’s office such as the dentist’s office for dental work (including braces). Here is a comprehensive list of things the IRS considers qualified medical expenses, but many people are surprised to find out their prescription glasses are included in this. That’s right – your HSA dollars can pay for your trip to the eye doctor and subsequent contacts or glasses purchase, even fancy Oakley ones (as long as they are a prescription).
Invest in Your HSA
You can use the money in your HSA to invest in low cost index funds like the one I discussed in the Betting On America article. This can help your HSA funds to compound over time passively, enabling you to have even more money set aside for medical expenses. This money comes out of your paycheck pre-tax, so you it can grow tax-deferred which is a huge benefit for you. Investing in your HSA requires you to keep a minimum amount in your HSA (for ours it is $2000) before putting money into investments. You can also decide to set a higher threshold if you want to have more cash in your HSA. The current family maximum deferral is $6750 a year, allowing for lots of room to meet your minimum money and then have an additional chunk to invest this year.
I am planning a post on how we optimize our HSA for retirement benefits, but if you want to read an excellent explanation of the opportunities available, check out the following article from the Mad Fientist: HSA – the Ultimate Retirement Account.
Flexible Spending Accounts/Arrangement (FSA)
There are several types of FSAs including Medical FSAs, Dependent Care FSAs, and even transit or adoption FSAs. We’ll stick to talking about the Medical and Dependent Care FSAs for the purpose of this article.
First, you cannot have a medical FSA if you have an HDHP and an HSA already (wow, that was a lot of abbreviations), so you have to choose which one will benefit you the most. The Medical FSA can purchase many things that cannot be purchased using an HSA. You used to be able to purchase over the counter medications, but that changed in 2011 to require a prescription for the over the counter medications to count. Although this probably significantly reduced the number of people binge purchasing Tylenol in December, it did not change the fact that you can use the FSA to purchase over the counter medical devices such as a box of band-aids, thermometers, crutches, or knee braces. You can use the FSA money to purchase things that would also qualify for the HSA, so there is undoubtedly more flexibility in the short-run with FSA money.
Use it or Lose it
During open enrollment, you will determine how much you want to set aside for the FSA for the following year. If you don’t use that money during the year (or in some circumstances, an additional 2.5 month “grace period”) then the money is gone. Poof. No benefit. Even though the money came out of your paycheck as prescribed, they money will be forfeited over to your employer. This is practically a poison pill when it comes to these plans. The Patient Protection and Affordable Care Act (Obamacare) permits employers to let their employees to hold $500 through for the following year, but employers do not have to allow that or the aforementioned grace period. It is best to have a specific plan for how you will use your FSA money before you put money into that bucket at open enrollment.
Early Access to the Funds
If you decide to designate $100 for each paycheck you get every two weeks, then you will have $2600 available to you at the beginning of the calendar year for the FSA. If you had a surgery or orthodontic work planned, this could be a great way to get access to the money earlier; however, you are forgoing the option an HSA for the entire year.
Dependent Care FSA
These accounts do not have the benefit of early access to the funds, but it does allow families to purchase dependent care for children under 13 when the use of that dependent care will enable the guardians of the dependents to return to work. Some families have two working parents who spend a tremendous amount of money on daycare – this can cut into that cost a bit, saving you a chunk of change if your marginal tax rate is high. The benefit is limited to $5000, which is probably not enough to cover a year of daycare. You can have both an HSA and a Dependent Care FSA at the same time.
Now that you’ve read this primer explaining HSAs and FSAs, it is time to see which options your employer offers. Which do you think is right for you? Let me know in the comments below. Coming up next will be a personal article about how we use our HSA to save money on taxes and build wealth for the future.