Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs)

 

Individuals increasingly turn to specialized accounts like Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) to navigate the complex tax landscape, considering healthcare costs as a significant aspect of financial planning. These accounts offer unique tax advantages and considerations that can significantly impact on your overall financial well-being. Using one of these plans may allow you to lower your tax bill and allows you to maximize the use of your health care dollars – both important considerations in and out of the tax arena. In this article, we will explore the ins and outs of HSAs and FSAs, helping you make informed decisions about your health-related financial planning.

 

CAVEAT – While this is tax centered discussion, I subscribe to the complex theory of “don’t let the tax tail wag the dog.” By this I mean that while tax considerations are present in most business and personal financial decisions, there may be considerations beyond tax in your decision. It may make more sense for a family to spend a little more for a health plan with a low deductible to spread out medical expenses and have a predictable monthly expense. The same is true in other contexts, taxes are an important part of your decision-making process, but it is not the only factor.

 

Understanding Health Savings Accounts (HSAs)

Health Savings Accounts, or HSAs, are designed to accompany high-deductible health insurance plans. Even if you are in a high-deductible plan, there are other limits, most notably that you cannot be enrolled in Medicare. This and other limitations make an HAS attractive for those taxpayers under 65.

Here is what you need to know:

Definition and Purpose: HSAs are tax-advantaged savings accounts dedicated to qualified medical expenses. Among qualified expenses and copays, prescriptions, dental care, contacts. X-rays and other expenses. They are considered tax-advantaged because of the three tax advantages they deliver – described below.

Eligibility Criteria: Explore the qualifications for individuals and families to participate in an HSA. See IRS Publication 969 for more information on what constitutes a “high deductible” health plan. For 2023, the minimum annual deductible for self-coverage is $1,500 for self only coverage and $3,000 for family coverage.

You can establish your own HSA with various providers, and you can consult with them to determine whether your health plan is eligible.

Triple Tax Advantage: Uncover the unique triple tax advantage, involving tax-deductible contributions, tax-free earnings, and tax-free withdrawals for qualified medical expenses.

·         (1) Your contributions to an HSA are made pre-tax, much in the same way 401(k) contributions are set up.

·         Pro-Tip – while you can make contributions outside of withholding from your paycheck, in so doing you lose the benefit of not having those dollars subject to Medicare and Social Security tax. For example, let us say you are in a 22% marginal tax bracket (that every additional dollar of income is taxed at 22%). If your contribution is deducted from your paycheck, it is not taxed at 22% AND you avoid the Medicare and Social Security tax, which is about 8%. Overall tax savings in this scenario is 30%. If instead your contribution is made outside of your paycheck, you only benefit from the marginal tax rate, losing out on the Medicare and Social Security deductions.

·         (2) Your contribution earnings are tax-free.

·         (3) As long as you use the funds for qualified medical expenses, the withdrawal is tax-free.

·         Pro-Tip – Check with your employer to see if they make matching contributions to your HSA. Employer contributions are not tax deductible, but the earnings remain tax free to you.

·         You can invest part of your HSA. This allows for future growth and other benefits for younger taxpayers.

·         HSAs are not “use it or lose it.” This plays a key role in tax planning strategies for younger taxpayers. It means that you can accumulate your earnings, tax-free, and not lose any benefits.

·         Pro-Tip – Starting at 65, there is no penalty for using the funds on non-qualified expenses. This means that you can use an HSA as a back door 401(k), in the event you are fortunate enough to need all the funds for medical expenses. As with a 401(k) you will pay taxes on amounts withdrawn, at the time of withdrawal.

·         Pro-Tip – partner with a known provider, a national brand name, or someone with whom you already have a relationship when considering establishing an HSA. They can offer advantages that other smaller brokers may not be able to match.

 

Summary

HSA shows many benefits for younger taxpayers and allows them to maximize their tax-savings potential beyond that provided by 401(k) and Roth IRAs. They are worth considering as a part of any young taxpayer’s tax strategy.

 

Understanding Flexible Spending Accounts (FSAs)

 

Flexible Spending Accounts, or FSAs, offer pre-tax contributions and tax-free withdrawals for medical and dependent care expenses. They are like HSAs, to a point, and thus are less flexible than HSAs. Now that you know about HSA’s, here are a couple of key differences:

 

·         FSAs are employer sponsored, so you cannot establish an FSA on your own initiative.

·         FSAs DO HAVE a “use it or lose it” provision. However, each plan may have a carryover provision of up to $500 or a grace period of 2 ½ months.

·         FSA is not portable. You cannot take it with you when you change employers.

 

Overall, FSA’s do over some benefits – there is some tax advantage in that deductions are pre-tax. However, there is no investment portion to an FSA. Having and participating in an FSA would be nice, but not as nice as an HSA.

 

Planning for the Future

 

HSAs present many more planning opportunities, both on a short term and long-term basis. The self-employed and other small employers often overlook the benefits of HSAs. It is a way to use the benefits of deferral and gain for those young taxpayers who are planning a family, have a family, or are 10 -20 years from retirement. The deferral opportunities are too good to overlook and deserve attention in any planning session dealing with income tax or retirement planning.

 

Conclusion

In conclusion, HSAs and FSAs are powerful tools for managing healthcare costs while enjoying significant tax benefits. As you navigate the tax landscape, consult with financial advisors or tax professionals to tailor these accounts to your unique circumstances. By understanding the nuances of HSAs and FSAs, you can make informed decisions that positively impact both your current and future financial well-being.