HSAs & FSAs

If it’s open enrollment time or you’re dealing with a life-changing event that affects your employee benefits, you may need to make decisions about HSAs and FSAs. Both Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) generally must be elected during open enrollment, if you wish to use them. Take advantage of possible tax savings by understanding how HSAs and FSAs work and determining what might be best for your situation.

One of the first steps is to try to anticipate what your expenses will be for medical and dependent care for the upcoming year. This can help you determine if/how you might want to use the accounts. Remember, you want to make sure you are choosing the right options for your life.

FSAs are different from HSAs because funds you set aside in an FSA that are not used by the end of that calendar year are possibly lost. In contrast, HSAs allow you to save not only for current medical expenses but future medical expenses as well, since any money in the account at the end of the year stays in the account and is available for future use.

An MSA Money Coach can help you sort through your options, explore possible tax savings and premiums, and consider factors like out-of-pocket expenses, dependent care costs, and other yearly financial responsibilities not covered by insurance.

Now, let’s take a deeper look at some of the options when it comes to HSAs and FSAs.

Health Savings Accounts

To participate in an HSA, you generally must enroll during the annual open enrollment period. HSAs are portable, meaning the balance is yours even if you are no longer eligible for your employer’s medical plan. Keep in mind that the IRS does have contribution limits for HSAs, which can be found in IRS Publication 969.

To have an HSA, you must be enrolled in a High Deductible Health Plan (HDHP).

Planning for a high deductible and lower premiums might be attractive, especially if you are healthy and have very few medical costs each year. That said, because medical expenses can hit unexpectedly, you will want to be financially prepared if you do incur medical expenses. Before enrolling in an HDHP, consider the budget implications and how you might address an emergency if one arose.

Triple Tax Advantage

There are some pretty significant ways that an HSA can benefit you in terms of potential tax savings.

1. The contributions are made with pre-tax dollars.
2. Any growth of the account value is tax-free while funds remain in the HSA for federal and possibly state.
3. Withdrawals from an HSA can be made on a tax-free basis as long as they are used to pay for qualified medical expenses.

It’s important to note that withdrawals are considered taxable income if they aren’t used for medical expenses. Plus, if the owner of an HSA makes a withdrawal prior to age 65 for non-medical expenses, they will incur an additional 20% tax penalty on the amount of the non-qualified withdrawal.

HSA funds can be invested.

Within an HSA account, you’re not limited to holding your balance in cash.  You can select the investment options so that you can be as conservative or aggressive as you choose to be. Keep in mind that market volatility can impact your account balance, so you will want to understand your tolerance for risk and select investments that are appropriate for you. Your Money Coach can help you understand the tools available.  Thinking about the growth of your long-term funds is key if you want to save for future medical expenses.

HSA funds do not expire.

If you don’t use the funds in your HSA each year, the funds can continue to grow. This is different from an FSA which must be used each year or the funds will be forfeited.

Flexible Spending Accounts (FSAs)

FSAs are accounts where employees can allocate pre-tax dollars through a payroll deduction. With an FSA, the money deducted from your paycheck is never taxed as long as it’s used to pay for qualifying expenses (as determined by the IRS). Qualifying expenses might include things like out-of-pocket medical expenses, dependent (child) care expenses, and adoption expenses.

Keep in mind that there are different FSA accounts for different types of qualifying expenses, and they are not interchangeable – they must be used for each specific purpose.

Health Care FSA

You can contribute up to the IRS limit each year, but it will be important to estimate your approximate known medical expenses that you will cover. It’s important to note that there are also different kinds of Health Care FSAs, each with its own features. Here are two examples:

• General Purpose Health Care FSA: Funds can be used for eligible medical, prescription drug, dental, and vision expenses for you, your spouse, or other eligible dependents.
• Limited Purpose Health Care FSA: Funds can be used for eligible dental and vision expenses for you, your spouse, or other eligible dependents.

For both the Limited Purpose and General Purpose Health Care FSAs, you may be able to roll over an allowable amount  (refer to IRS Pub 969) or have a grace period in the next year to use the remaining funds.

Once you determine which (if any) Health Care FSAs are available to you, consider which one makes sense for you and your dependents. A Money Coach can help you walk through the options and talk about the pros and cons.

Dependent Care FSA

The funds in this type of account can be used to cover childcare and eldercare. Keep in mind that, unlike the Health Care FSAs, the Dependent Care FSA has a “use it or lose it” rule where you cannot roll over funds. This makes it all the more important to plan ahead and estimate the funds you may need during the plan year.

Dependent Care FSA or Child-Care Tax Credit?

As we mentioned earlier, the Dependent Care FSA allows you to set aside pre-tax dollars (up to the annual limit) for qualifying expenses. The federal tax laws also provide a tax credit for dependent care expenses that are not reimbursed by an employer or paid under a state or federal grant program. IRS rules specify that you can’t use the FSA and apply for the tax credit with the same funds.

So, which one do you use? The answer could be somewhere in between.

If you have two or more eligible children and you have more qualifying expenses than the maximum contribution limit of your FSA, then it may be possible to apply the tax credit to the difference of what you put into the FSA and the annual limit of the tax credit.

Always check with a tax advisor before making these decisions, as other factors may influence your situation, and tax laws change periodically.

For annual contribution limits and a list of expenses covered by a DCFSA, check IRS Publication 503 for more information.

Other Considerations & Planning for Households with Two Employers

It is not permissible to have both an HSA and a general health FSA. Additionally, a couple cannot have both, such as when they have different benefits from different employers. As a couple, open enrollment is a good time to review each of the individual benefits offered to make the most of coverage for the household.

How can MSA help?

Explore how MSA and working with a Money Coach can help you address the best plan of action for your personal situation.
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Information provided in this article is for informational purposes only and is not intended to offer specific personalized investment, financial planning, tax, legal or accounting advice.  We recommend that you consult an attorney, tax advisor or accountant regarding your unique circumstances.

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