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HSAs vs. FSAs: What You Need to Know

By Kate Rockwood | October 26, 2017 | Rally Health

FSA? HSA? Before the alphabet soup of health care savings plans makes you shut down, let us offer this PSA — ahem, public service announcement: Understanding how a health savings account (HSA) works could save you serious money, whether you have major medical bills this year or not. “This is one way to take control of the rising cost of health care,” says Todd Berkley, author of HSA Owner’s Manual.

And rise it has: As employers have shifted more cost-sharing to employees, high-deductible health plans have become more common, Berkley says, and out-of-pocket expenses have climbed. On average, a single individual now pays $1,478 toward a deductible, up from $991 just five years ago, according to the Kaiser Family Foundation. That means the average person is shelling out nearly $500 more for covered health care services before his or her insurance plan starts to pay.

For patients, HSAs can be a savvy way to sock away money in case they need to pay that high deductible. But, like Flexible Spending Accounts (FSAs), which have long been popular to help defray health costs, HSAs bring tax benefits: They allow an individual to set aside untaxed income for eligible medical expenses, and spend that money tax free when needed.

Last year, more than 20 million Americans jumped on the HSA bandwagon — a 29 percent increase from the year before, according to Devenir’s annual survey. But does this type of savings account make sense for your situation? We’ve got you covered:

What an HSA Is — And What It Isn’t

You’re probably already familiar with an FSA, which is a health-related spending account: You estimate how much you’ll spend on out-of-pocket medical expenses that year, then have your employer set that amount into a separate, tax-free account to be used when you need it. If you max out the $2,600 cap and have a 30 percent tax rate, that FSA could save you $780 in taxes.

Of course, that assumes you use every dollar you’ve set aside. FSAs are often criticized for having a “use it or lose it” nature — meaning your employer gets to keep any funds you don’t spend that year (or early the next). So if you over-estimate your expenses, you could potentially lose more money than you’re saving in taxes.  

While HSAs are also a way to spend pre-tax dollars on medical expenses, the similarities pretty much end there, says Matthew Clarkin, president of the consulting firm Access Point USA. With an HSA, you choose how much you want to save each year (and in some cases take advantage of employer-matched contributions), and that money gets deposited into a special account. But instead of just sitting there for one calendar year, those funds can be invested and rolled over from one year to the next. That puts an HSA more in line with long-term savings accounts, like a 401(k), than a simple spending account, says Clarkin. “It’s a tool that can help you with deductibles now, but used correctly, can also have substantial long-term benefits — like saving for big expenses in retirement without being subject to the same taxes your 401(k) might be.”

In fact, HSAs have three separate tax benefits: The money you deposit into the HSA is either pretax dollars (if made through a payroll deduction) or tax deductible (if you make the deposits yourself). Then, whatever money grows in that investment account isn’t subject to taxes. And when you withdraw the original funds, you don’t have to pay taxes on that portion either — as long as you’re using them for approved health expenses.

Who Qualifies

HSAs are available to any individual who has what the IRS considers to be a high-deductible health plan — meaning an annual deductible of at least $1,300 for individuals and $2,600 for families. If you qualify, you are able to contribute $3,400 annually for self-coverage or $6,750 for families. Individuals 55 and older are allowed an additional contribution amount of up to $1,000.

Keep in mind that once you have an HSA it’s yours to keep — even if your next job doesn’t have a high-deductible plan, explains Clarkin. “Millennials have a greater tendency to move around and change jobs, and they can take the HSA with them wherever they go.”

Where You Sign Up

HSAs are usually offered as a benefit of employment, and this is your best bet to get those matched contributions. However, if your employer is not among the 44 percent of companies that offer an HSA, you don’t have to worry. You can also apply for one through a bank, credit union, or private broker that specializes in health insurance. The IRS also has HSA trustees who can answer your questions by phone (1-800-829-1040 for individuals;1-800-829-4933 for businesses).

When HSAs Work  

When there is an eligible medical expense, your savings are immediately available to you, linked to a debit card or personal checks. Monthly insurance premiums are not eligible, but qualified expenses include: deductibles, copays, coinsurance, medical equipment, prescriptions, even dental and vision costs.

However, it’s worth noting that you don’t have to spend your HSA funds on those health expenses. “If you can afford to maintain those costs out of pocket, that can sometimes be the smartest long-term move,” says Roger Wolhner, a financial planner and author of The Chicago Financial Planner. That’s because every time you shoulder an expense out of your paycheck and leave the HSA funds untouched, you’re leaving more money to grow — tax free — for longer.

And your gray-haired self may one day thank you: “People tend to dramatically underestimate their health care costs in retirement,” he says. “And long-term care costs are rising faster than inflation.” Wolhner points out to clients that an HSA compounds and continues to avoid taxes, even the capital gains tax, as long as you spend only on health-related costs when you finally use it.

Why Now?

The majority of people first learn about high-deductible health plans and HSAs because their employer-sponsored offerings shift, says Berkley. And there can be a learning curve to figuring out how to proactively save for and manage higher out-of-pocket costs. “But we find that once people get through the first year, most people are really satisfied with this type of account.”

Still, high-deductible plans and HSAs aren’t for everyone. Depending on your health conditions, your tax rate and your tolerance for juggling health bills and accounts, it might make more sense to stick with a traditional plan. Keep in mind that for an HSA to work, you have to set aside enough money to fund it, or you could find yourself skimping on necessary medical care when faced with a big bill. A 2015 survey by Families USA found that nearly 30 percent of individuals with deductibles above $1,500 avoided tests, treatment, follow-up care, and filling prescriptions because they couldn’t afford the out-of-pocket costs.

Tax breaks are great — and for savvy savers, an HSA offers plenty of them — but that’s not the only thing to consider when choosing a health plan. If you’re concerned about your ability to fund and manage an HSA or don’t want to worry about losing investments in a down market, a traditional health care plan supplemented with an FSA may be the wiser (and healthier!) choice.

Kate Rockwood
Rally Health