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  3. How Do HSAs and FSAs Work?

How Do HSAs and FSAs Work?

Health care costs can add up quickly. Even with insurance, expenses like copays, deductibles and medications could take a big bite out of your budget. In 2020, the average person in the U.S. spent $1,181 on out-of-pocket medical costs, according to research from the Peterson Center on Healthcare and the Kaiser Family Foundation. That’s in addition to health insurance premiums.

Health savings accounts (HSAs) and flexible spending accounts (FSAs) can both help maximize your savings. Each has its own unique perks. Here’s a rundown of how they work so you can decide if they fit into your financial plan.

What is an HSA?

An HSA is a type of savings account that’s specifically dedicated to health care spending. One draw is that your contributions reduce your annual taxable income. In 2022, you can contribute up to $3,650 pre-tax to an HSA for individual coverage. That number jumps to $7,300 for family coverage.

The money in the account grows tax-free. You’ll also enjoy tax-free withdrawals if the funds are used to cover qualified medical expenses. Health insurance premiums are typically excluded, but eligible costs generally include copays, deductibles, coinsurance and more. One word of warning: if you withdraw funds for nonqualified expenses, that money will be taxed as ordinary income. You could also be charged an additional 20% tax.

On the upside, once you turn 65 (or in the event that you become disabled), HSA funds can be used for anything you like—not just eligible health care expenses. In this way, an HSA can also provide retirement income. Just keep in mind that you’ll still be taxed on these distributions. Withdrawals aside, some HSAs allow you to invest your funds in a variety of securities. This may include stocks, mutual funds and exchange-traded funds (ETFs). 

To qualify for an HSA, you must be enrolled in a high-deductible health plan. In 2022, the minimum deductible is $1,400 for an individual; $2,800 for a family. HSAs are sometimes offered as an employee benefit. Over a third of organizations that do offer them automatically enroll employees who sign up for an HSA-qualifying health option in an HSA, according to a 2021 Plan Sponsor Council of America survey. 

If an employer-sponsored HSA is available but you haven’t been automatically enrolled, you can ask your company about how to do so. Those who don’t have access to an HSA through work can open one themselves. Certain banks and insurance companies are qualified HSA providers.

How does an FSA work?

FSAs are only available as an employee benefit. They’re funded with pre-tax contributions that are typically made through automatic payroll deductions. From there, you can tap FSA funds on a tax-free basis to reimburse yourself for certain expenses. FSAs come in a few shapes and sizes. Some are like HSAs and are earmarked for medical costs. A dependent care FSA, on the other hand, covers bills related to childcare and elder care.

To provide a helpful comparison of HSAs and FSAs, let’s focus specifically on health care. In 2022, the contribution limit for a health FSA is $2,850. (Your employer may opt for a lower limit, so be sure to check your benefits.) With an HSA, any remaining balance you have at the end of the year will automatically carry over into the next year. However, FSAs are structured differently. If you have leftover money at the end of the year, your employer may choose to give you two and a half extra months to spend the money or allow you to carry over up to $570 into the next plan year, as permitted by applicable law.

Which one is right for you?

If you have access to an HSA or health FSA, you probably are prohibited from contributing to both during the same calendar year. (You can if you have something called a limited purpose FSA, which is designed for dental and vision expenses.) With that said, you’ll want to weigh the pros and cons to decide which one makes the most sense for you. You might want to consider the below:

  • Am I okay with potentially forfeiting any unused funds in a health FSA at the end of the year?
  • Am I looking for a long-term savings vehicle that can grow over time? If so, an HSA can be appealing—especially since you can use the funds for non-medical expenses after you turn 65.
  • Do I have a lot of health care expenses? If so, am I okay with the lower FSA contribution limit?

When all is said and done, you’ll want to look at your overall financial health to see which option is the best fit for you.

 

All information herein is for educational purposes only and should not be relied upon for any other use. The information herein does not constitute the rendering of financial, business, accounting, securities, tax or legal advice or other professional advice by DailyPay. No fiduciary obligation or duty exists, or is created, between you and DailyPay. DailyPay does not warrant the completeness or accuracy of any information provided to you.

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