The ABCs of HSAs and FSAs

Health insurance doesn’t cover everything and your health expenses can quickly pile up. Fortunately, there are ways to reduce your costs.

Health savings accounts (HSAs) and healthcare flexible spending accounts (FSAs) are two additional benefits your employer may offer to help reduce your medical expense. Both allow you to set aside pre-tax dollars that can be tapped to pay for such things as eyeglasses, dental visits, prescription drugs, health insurance co-pays and other “qualified medical expenses.”

Setting aside money pre-tax is a big deal, because that means you are setting it aside before taxes are assessed, and that any such contributions don’t count toward your adjusted gross income at the end of the year.

But in order to take advantage of FSAs and HSAs, it’s important to understand how they work and the rules that apply. If you’re fuzzy on the details, you’re not alone: about 73 percent of respondents to a 2013 survey by Fidelity Investments said an HSA and an FSA were “pretty much the same thing,” or were unsure. In fact, the two savings vehicles have a number of important differences.

With open enrollment season underway in many workplaces, you might find yourself faced with the option of choosing a flexible spending account or a health savings account. Read on to learn more:

What Do I Need To Know About FSAs?

FSAs are employer-sponsored accounts that let you set aside pre-tax dollars to foot the bill for eligible healthcare costs.

These days, the majority of employers offer FSAs and they’re certainly worth a look. Depending on the limits set by your employer, you might be able to set aside as much as $2,600 of your salary in an FSA in 2017. Contributions to your FSA are funded through pre-tax payroll deductions. Your employer might kick in money as well. Before you get too excited, it’s important to understand one thing: Money in your FSA that you don’t use before the end of the plan year is generally forfeited. “If you don’t use it, you lose it,” said Karen Pollitz, a senior fellow at the Kaiser Family Foundation.

(Employers have the option to offer employees a brief grace period to spend unused funds. Alternatively, they can allow employees to carry over up to $500 to the following plan year. These details will vary by employer.)

If you decide to contribute to an FSA, it’s important to carefully estimate what your out-of-pocket health costs might be for the coming plan year. Do you plan to buy glasses? Do expect to have surgery? Do you plan to leave your job mid-year?

Think carefully before you make a commitment. Generally, FSA decisions can be made only once a year, during your employer’s open enrollment period. Unless you encounter a “qualifying event,” such as a change in marital or employment status, you must live with your decision until the next open enrollment period rolls around. And if you leave your job, you will also lose access to any funds remaining in your FSA account.

What Do I Need To Know About HSAs?

An HSA is another type of tax-advantaged medical savings account. It has some features that could help you save even more on medical expenses and possibly grow your money. But there’s a catch. HSAs are designed to be used in conjunction with high deductible health plans (HDHP). In fact, you can only contribute to an HSA if you’re enrolled in a HDHP.

In 2017, to be classified as a high deductible health plan, a plan must have a minimum deductible of $1,300 for an individual or $2,600 for a family, and must meet other requirements, the IRS says.

The maximum annual HSA contribution allowed for 2017 is $3,400 for an individual and $6,750 for a family. Those 55 years or older who are not enrolled in Medicare can make an additional “catch-up” contribution of up to $1,000. It’s worth noting that the IRS also sets a maximum limit for out of pocket expenses. In 2016, that limit was $6,650 for individuals and $13,100 for families.

In many ways, HSAs are similar to 401(k)s. If you set up an HSA at work, your money is deducted from your paycheck, pre-tax, and you can generally choose among investments such as stocks and mutual funds in which to invest that cash.

Your dollars can be rolled over year after year — meaning there’s no “use it or lose it” constraint. Your employer might make contributions into your health savings account, as well.

HSAs “are called savings accounts, but they’re really investment accounts,” Pollitz said.

Unlike a 401(k), withdrawals from an HSA are never taxed so long as the money is used for qualified medical expenses. If you choose to set up an HSA on your own, the same tax features apply.

In addition, an HSA is “portable,” meaning you can take the account with you if you switch jobs or leave the workforce. The money in a health savings account belongs to you, whether you use it for future medical expenses or not. However, if you don’t put that money toward medical expenses, you will be subject to income taxes on that money and to a 20 percent penalty if you use it for non-medical expenses before the age of 65.

Can I Contribute To Both An FSA And An HSA In The Same Year?

Generally speaking the answer is no.

There are exceptions. Your employer might offer something called a “limited purpose FSA” used to fund dental and vision costs. If this is the case, you can contribute to both accounts.

How Do I Make A Wise Decision About FSAs and HSAs?

You’ll need to think about your health as well as your overall finances. You might want to seek advice from a tax professional, a financial planner, or from your human resources department.

“It’s not a lot of fun, but read your open enrollment materials,” Pollitz advised. “Go to human resources and ask questions.”

It could make you feel healthier — and improve your bottom line.