Wealth Chronicle: Unpacking Medical Savings Accounts

Until you turn 65 and qualify for Medicare, you will need some type of medical coverage. Whether it’s participating in your company’s health plan, your spouse’s company health plan, or purchasing coverage in the insurance marketplace, you’ll need to determine which options are best for you. . The key to understanding health insurance is knowing what your plan costs, what it includes, and who it covers. In this column, we unpack two additional health savings options worth considering – the Health Savings Account (HSA) and the Flexible Spending Arrangement (FSA).

HSAs are key components of many health insurance plans, both in employee group plans and for individual purchasers. This is a type of medical savings account that allows you to set aside pre-tax money to pay for eligible healthcare expenses. An HSA allows for tax-free reimbursement of eligible healthcare expenses – but, if asked, you must be able to prove them by producing receipts. Unlike an IRA, withdrawals from an HSA will be tax-free if used to pay for qualifying expenses. And, unlike an insurance policy, HSA dollars can be used for a wide range of expenses, such as contact lens solution or a wig after chemotherapy.

To be eligible for an HSA, you must be enrolled in an HSA-qualified, high-deductible health insurance plan, which for most people means plans with deductibles of around $5,000 for a family and $2,500 $ for an individual. Additional exclusions include the following:

• You cannot be enrolled in Medicare (meaning you cannot contribute to an HSA if you are enrolled in Medicare, but you can receive payments if you have an existing HSA).
• You cannot get coverage through a spouse’s non-HSA health insurance plan or flexible spending account.
• You cannot be considered a dependent on someone else’s tax return.

An HSA works very similarly to your workplace retirement plan: you (the employee), your employer, or both, put pre-tax dollars into an HSA to pay for out-of-pocket health care costs. The maximum total contribution for 2023 is $7,750 for families and $3,850 for individuals, plus a catch-up provision of $1,000 for participants age 55 and older. You own the assets of the HSA for the life of the account and can access them even if you change jobs or retire.
The tax benefits are generally better for HSAs than for 401(k)s and IRAs. On the one hand, the money that comes in is not taxed, the assets in the account grow tax-free as long as they are held in the account, and the withdrawals used to pay for eligible healthcare expenses are also tax exempt. (However, if the withdrawals are not used for eligible expenses and you are under age 65, you will have to pay federal income tax and a 20% penalty.) Second, since at age 65 years you can make withdrawals for non-medical expenses and pay tax on them, just like a traditional IRA payment, HSAs can be used as a supplemental retirement account. Also, if you don’t claim reimbursement as expenses are incurred, you can be reimbursed for them years later, as long as you have receipts. Finally, you can use tax-free withdrawals to pay for healthcare costs in retirement, such as Medicare Part B and Part D premiums and Medicare Advantage premiums.

That being said, HSAs may not be for everyone. Evaluating high deductible coverage with an HSA can be tricky, with many variables. For example, your decision to open an account might ultimately depend on whether your employer subsidizes your health insurance or the HSA, the expected cost of future drug prices, and whether treatments for chronic conditions are subject to your deductible. . Consulting a knowledgeable financial advisor can be helpful when sorting through these variables.

Like an HSA, an FSA acts as a savings account that allows you to set aside pre-tax money to pay for eligible medical expenses, even those not covered by regular insurance. Contributions are federal and most state income tax deductible. The contribution limit for 2023 is $3,050, up from $2,850 this year. And like an HSA, money held in the account grows tax-free and withdrawals are tax-free if used to pay eligible medical expenses.

But there are significant differences between an FSA and an HSA that are worth noting. First, your employer owns the assets in the account, and if you don’t use all of the money in your account by December 31 each year, you can revert to your employer. If you have an FSA, you’ve been spared having to spend the assets during the pandemic (the IRS allowed full deferrals in 2020, 2021, and 2022; but only $570 can be carried forward in 2023).

Second, FSAs can only be used on qualifying healthcare expenses – there is no provision for making unqualified withdrawals and paying a penalty.

Finally, people often confuse FSAs and HSAs – particularly how FSAs have short-term, exclusively medical use, and HSAs can be used for longer-term (and non-medical) planning purposes. You should also clearly state whether the FSA you are considering has a deferral provision or a “grace period”. A carryover is the fixed amount, set by your employer subject to IRS limits, that can be carried forward from one year to the next. A grace period, also at the choice of the employer, gives workers an additional 2.5 months (usually until March 15) to spend their balance from the previous year.

Having an HSA or FSA in your area can be a big help if you or family members are struggling with high or unexpected health care costs not covered by regular insurance.