A whirlwind tour of tax-free medical accounts
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One of my friends recently discovered the joys of using a Flexible Spending Account, and suggested I write a post on it. The topic of tax-free medical accounts, which includes both FSAs and Health Savings Accounts (HSAs), is a huge one, and definitely beyond the scope of a single post (and my knowledge!); instead of telling you everything there is to know, I’m going to give you a decent overview and provide you with pointers to the material that will address your specific situation.
First, what’s the difference between an FSA and an HSA? There are several.
- With an FSA, once the money is in the account, you have to spend it on qualified medical expenses within the year, or you lose the money. With an HSA, the money carries over from year to year.
- Individuals can make direct contributions to their HSAs or the HSAs of others, and the account-holder’s employer (if they have one) can also make contributions. An FSA is available only through an employer, and employees can contribute through a salary reduction agreement.
- An HSA requires a certain kind of health plan (”high deductible health plan” or HDHP); an FSA doesn’t have this limitation.
- An HSA belongs to the employee and travels with them if they leave a job; an FSA is forfieted if you leave a job.
- An HSA has a cap on contributions, depending on your age and your insurance; an FSA doesn’t have this limitation.
FSAs and HSAs have some similarities, too.
- The basic concept is the same. You (or your employer) contributes money into the account. This money is pre-tax. That’s a huge benefit, because depending on your tax bracket, you’re automatically saving 10-30% right off the top by not having the money taxed.
- In both cases, when you have a “qualifed medical expense”, you can withdraw money to pay for it. This is in the form of a reimbursement for whatever you payed for.
All things being equal, I would recommend you choose an HSA over an FSA; the money roll-over from year to year and the fact that you get to keep the account regardless of where you work are excellent benefits. Theoretically the cap on contributions might cause trouble, but since you can roll over from year to year, there’s nothing to keep you from doing the max each year and ending up with a substantial account.
All that said, I have an FSA and not an HSA. Why? Because I’m not eligible for an HSA. Here’s the thing: if your employer, or your spouse’s employer, offers a general FSA, you can’t have an HSA. That’s me. I love my FSA and all, but I’m also stuck with it. However, if we ever come to a place where my husband is also self-employed or he changes jobs, I’d jump on the HSA in a heartbeat.
A few notes:
There are actually two types of FSAs: medical and childcare. If you’re paying childcare expenses and your employer offers you a FSA, you can pay for your childcare tax-free. Just like the medical FSA, though, anything in the account that you don’t use by the end of the year is history, so try and make your budgeted cost as accurate as possible (maybe even go a little low).
The plans I’m discussing are American plans. Some other countries offer similar plans, and it’s definitely worth looking into.
I’m not an expert. I’m attempting to summarize what I’ve read on the topic, but you should absolutely not consider this professional advice by any stretch of the imagination. Research it for yourself if this has caught your attention; some excellent starting points are listed below.
Some resources to learn more:
The IRS’s guide to Health Savings Accounts and Other Tax-Favored Health Plans provides a good deal of useful information. The YMCA, of all places, has a nice little PDF chart of the differences between FSAs, HSAs, and their cousins the HRAs. If you like the FAQ format, the U.S. Treasury has an HSA Frequently Asked Questions page. Wikipedia has basic articles on both FSAs and HSAs. I read some excellent articles on a blog about a month ago on this topic. For the life of me I can’t find them again (naturally!), but if you have a blog that’s discussed the issue, by all means, give us a link to the post in a comment.
Excellant post and thanks for the reminder to check with my HR about getting this setup
I believe one of these also lets you pay for OTC stuff as a medical expense–meaning all your vitamins, nutritional supplements, cold/allergy remedies, aspirin, eye drops/contact lens solutions, etc. all count as qualified medical expenses. Trouble is, I can’t remember which one. I’ll have to look it up.
my FSA lets me count little over the counter stuff like contact lens solution, cold sore medication, aspirin, condoms, etc.