In last week’s post, I discussed the various options for obtaining healthcare, as well as the questions that you need to ask yourself to ensure that your needs are met. This week, I want to discuss the various spending/savings vehicles that can be used to pay for healthcare services.
In general, an emergency fund being used for medical expenses is a very legitimate use for that money. However, the ideal situation would be to have money set aside specifically for these needs. There are several different types of accounts that can help with this effort that provide some tax benefits.
Flexible Spending Arrangement (FSA)
If you are able to use an employer based health insurance plan, you are eligible to deposit money into a flexible spending arrangement or account (FSA). The benefit is that this money goes into the account tax free, meaning that it is either taken from your paycheck directly or will reduce your overall taxable income.
There are generally two types of FSAs:
- Health Care Spending Accounts (HCSA): For general medical, dental, OTC expenses for yourself and those on your plan.
- Dependent Care Spending Accounts (DCSA): Sometimes also called a Dependent Care Assistance Program (DCAP) or Dependent Care Account (DCA). This account is specifically to be used in costs for a dependent, meaning expenses like daycare for a child or eldercare for an ailing spouse or relative.
FSAs can be spent on medical expenses, including deductibles, copayments, medications (prescription and over the counter meds with a prescription) and medical procedures. These payments are made also income tax free. The full list can be found on the IRS website.
Tax free money going in and out of the account sounds pretty great, right? Well, there’s a catch. This account is of the “use it or lose” genre. This means that if you do not use the money deposited in this account within the calendar year, then that money is lost and cannot be recovered. There are two caveats to this that employers have the opportunity to offer:
- 2.5 months worth of an overrun on the account, which would allow you to continue to spend this money through March 15th of the following year.
- Allow for a carryover of up to $500. This doesn’t mean that in year 1 you roll over $500 and year 2, you roll over $1,000. Only $500 from year to year can be carried over.
This year’s limit was $2,700 for either an individual or a family. However, the most important note if your insurance plan allows for a FSA is to be sure to deposit no more than you will need for the coming year into the account. Historical spending is a good source to begin estimating expected costs.
Health Reimbursement Arrangement (HRA)
Not many employers offer this type of plan, but the essential point of an HRA is that your employer sets money aside into this account and you can then request reimbursement for qualified expenses.
The main benefits of this type of arrangement from your employer are:
- Your employer is the only one who makes contributions to this account (and there is no contribution limit).
- Amounts roll over from year to year.
- There is no federal or state tax paid on the amount added to the HRA by the employer.
Health Savings Account (HSA)
The main benefit of a health savings account (HSA) over an FSA is that you own the account and therefore it will roll over from year to year even regardless of if you leave your current company. Due to this roll over perk, any medical expenses can be reimbursed from this account at any time as long as you have proof of purchase (receipts). This means that you could purchase something today and not reimburse yourself for 20 years as long as you keep your receipt.
Why would you wait 20 years to reimburse yourself you ask? Well, another plus of HSAs over FSAs is that any amount over $1,000 sitting in the account can be invested. Meaning that you can allow that money to grow in your HSA until you want to spend it on a new qualified medical expense or reimburse yourself for an old expense. Let’s see what it would look like if you added an extra $1,000/year to an HSA and invested it.
Wow. Having over $100,000 set aside for medical expenses later in life is a powerful thing. This is made made even more important when considering this last advantage. While the FSA is double tax advantaged, the HSA is TRIPLE tax advantaged. I know that sounds made up, but hear me out. Not only are your contributions added federal and state tax exempt, they grow tax free AND any payouts for qualified medical expenses are tax free.
While this sounds amazing, there are caveats. In order to have an HSA, you must be enrolled in a high deductible health plan. This means that you will have to spend at least $1,350 for an individual or $2,700 for a family on medical expenses on your own dime before your insurance will kick in anything for non-preventative services. This is on top of what you will already pay for the monthly premium to have the plan in the first place.
My only warning about HSAs is not to let the triple tax savings or the investment vehicle persuade you from first using other retirement vehicles to save. While an HSA can be a great tool if you are eligible, the benefits only come into play for qualified medical expenses. It becomes a matter of saving for one line item in your budget versus all of them at once. What you gain in tax benefits you lose in flexibility.
Wrap It Up!
When comparing these types of accounts, an easy way to keep things straight is an “arrangement” is made by your employer and they own it. An account is owned by you and moves with you regardless of where you work. So, take a look at what kind of savings/spending vehicles are available to you with your current plans and see if it makes sense for you and your family to add to one. As always, an objective voice here can be helpful so if you still have questions, please consult a fiduciary financial advisor or financial coach to help you make these decisions.
Did you find this guide helpful? If you have any other questions, let me know in the comments below!