Flexible spending vs. health savings accounts: How to choose

December 7, 2018
Jeff Witz, CFP

"Health care flexible spending accounts (FSAs) and health savings accounts (HSAs) are great ways to pay for medical, dental, and vision expenses," writes Jeff Witz, CFP.

My employer offers both a health care flexible spending account and a health savings account. Can I use both and if not, which option is better?

Health care flexible spending accounts (FSAs) and health savings accounts (HSAs) are great ways to pay for medical, dental, and vision expenses. Both allow an individual to put money into the account on a pre-tax basis and take the money out of the account tax free as long as it is used for qualified medical expenses. Qualified expenses include deductibles, copays, coinsurance, and other expenses not covered by your insurance plan.

These accounts cannot be used to pay for insurance premiums, and removing the funds for non-qualified purposes results in having to pay taxes and a 10% penalty if under age 65. Both accounts can be an effective way to save for your medical expenses, but an individual cannot have both an FSA and an HSA. Determining which option is best for you requires an understanding of the nuanced differences between the two.

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An FSA allows you to contribute up to $2,650 (2018) each year on a pre-tax basis. FSAs are use-it-or-lose-it accounts, meaning any balance remaining at the end of the year will be permanently forfeited. For this reason, when using an FSA, it’s important to estimate your health care costs as accurately as possible. Some FSAs allow you to roll over $500 to the following year, but anything above $500 is forfeited. Other FSAs will extend the deadline to use the funds by 2½ months, but then any carry-over balance still remaining by mid-March is forfeited.

Unlike an HSA, you do not need to be covered by a high-deductible health insurance plan to be eligible to use an FSA. If you are currently using an FSA, be sure to check your current balance and, if necessary, determine how to use those funds before they are at risk of being forfeited.

HSAs are like FSAs, but with some added features. First, you must have a high-deductible health plan (HDHP) to be eligible to use an HSA. The U.S. government currently defines an HDHP as one with a deductible of $1,350 or greater ($2,700 if the plan is used by the whole family) and an out-of-pocket maximum equal to or greater than $6,650 ($13,300 for family).

Next:"HSAs are one of the only accounts that provide tax benefits in the contribution, growth, and distribution stage"If eligible, an individual can contribute up to $3,450 ($3,500 in 2019) on a pre-tax basis into the account or, if the entire family is on the plan, $6,900 pre-tax ($7,000 in 2019). One main difference between HSAs and FSAs is that with HSAs, once a contribution is made, the funds can be invested in mutual funds, exchange-traded funds, stocks, and other investments to potentially help grow the balance. HSAs are one of the only accounts that provide tax benefits in the contribution, growth, and distribution stage. The investments grow tax free, and as long as the money comes out of the account for a qualified purpose, no taxes are due on the investment gain.

Another difference between HSAs and FSAs is that any remaining balance in an HSA can be rolled over each year. If you don’t use all the funds, you can continue to invest year to year, so you never have to worry about forfeiting your contributions. Some individuals continue rolling over their balance all the way into retirement.

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HSAs can be used to pay for Medicare Parts A, B, and D premiums and Medicare HMO premiums. However, premiums for a Medicare supplemental policy, such as Medigap, are not eligible expenses. Some use their HSA as a supplemental retirement account earmarked specifically for medical expenses in retirement.

Overall, FSAs and HSAs are useful tools for saving and paying for medical expenses. Each option has advantages and disadvantages. We recommend speaking with your financial adviser to determine which option is best for you.

 

My HSA does not cover all vision and dental expenses. Is there an option to save for those expenses in a tax-advantaged way?

A limited-purpose FSA (LPFSA) is a health care spending account that can only be used for eligible vision and dental expenses. Unlike a health care FSA, however, an LPFSA can be held at the same time as an HSA. When coordinated with an HSA, the LPFSA can further reduce your taxes while allowing you to allocate HSA funds to other purposes-including retirement. Funding dental and vision expenses from an LPFSA may allow you to keep more savings in your HSA. Over time, those additional savings can help your retirement nest egg grow larger.

 

Mr. Witz is educational program director at MEDIQUS Asset Advisors, Inc. in Chicago. He welcome readers’ questions and can be reached at 800-883-8555 or witz@mediqus.com

The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.