How to Save Money with the Alphabet Soup of Healthcare Accounts
As healthcare costs continue to rise, planning for your current and future healthcare needs is becoming more complex and costly. Three account options are available to help Americans deal with the rising cost of healthcare: the Health Savings Account (HSA), the Health Reimbursement Arrangement (HRA), and the Flexible Spending Account (FSA).
Each of these accounts has their own advantages and disadvantages. Understanding the differences between them can help you to choose more wisely which account(s) is most beneficial to your family.
Health Savings Account (HSA)
An HSA acts like your retirement investment accounts, except the money is intended for medical care throughout your entire life. Money in an HSA can be invested in a wide variety of investments including mutual funds. Your employer may offer an HSA, but you can also set up an account on your own.
The HSA is probably the most tax-advantaged account Congress has given us. You can deposit money into the account and take a tax deduction for the amount you contribute, up to the limit. The money then grows tax free based on your investment choices. Additionally, you get to take the money out tax free provided you use the money for qualified healthcare expenses. This triple tax advantage is unlike any other account, and even beats your IRA and 401(k) options. One caveat, though, is the IRS will determine if you've used the money appropriately, so make sure to keep receipts and documentation for tax time.
The biggest limitation of the HSA is you need a High Deductible Health Plan (HDHP) to access one. Many employers don't offer HDHPs as part of their benefits offerings, so you may not qualify. If neither you nor your spouse have an HDHP at work, you won't be able to take advantage of the HSA. You could look at buying the plan separately, but that would likely cost you more than the HSA advantages give you.
What to Do
I'm a big fan of the HSA for a variety of reasons, including the triple tax advantage and the ability for your money to grow as an extra retirement fund. You can learn more about the HSA by reading Why you need an HSA, and then explore with your employer if you have a HDHP option at work.
Health Reimbursement Arrangement (HRA)
The HRA is an account owned, set up, and funded by your employer. Unlike the other two accounts, the HRA is completely at the discretion of your employer. As companies have moved to HDHP, employee concern over having to pay the high deductible has led some employers to offer assistance through HRAs. The employer places money into the account, which can be used to help offset the costs of paying the deductible.
Because the HRA is funded by your employer, you get no tax deduction for the money contributed. It wasn't your money, after all. The benefit, though, is the contributions are not counted as income.
The HRA is completely discretionary for your employer. Although the IRS has requirements for an HRA, the details of the rules and guidelines will be determined by your employer. Additionally, if you leave your job, you most likely will lose any money contributed since the money isn't really yours to begin with.
What to Do
HRAs pair nicely with HSAs and FSAs, so contact the HR department at work to see if your company has an HRA. If you do have access to an HRA, make sure you are using it regularly so the account doesn't grow so big it becomes an anchor attaching you to your job.
Flexible Spending Account (FSA)
The flexible spending account is another employer-controlled account, except this time you fund the account through a payroll deduction. Contributions are effectively held in a savings account and you can use the money for qualified medical expense. Your employer will monitor if the expense is qualified and may require receipts or other documentation.
The payroll deduction lowers your salary, effectively providing you with a tax deduction for the amount you contribute. FSAs also have lower contribution limits than HSAs do, so you won't get the same tax deduction you could get through an HSA. One advantage of the FSA, however, is the money goes in before you are 'paid,' so you will save on the payroll taxes as well as the income taxes.
Like the HRA, the FSA is offered only by your employer. FSA money, however, doesn't roll over from year to year. Each year, if you don't use the money, you will lose it. Your employer may allow you to roll over up to $500 or give you a until March 15 to use the money in the next year. Even so, you should expect to lose any money you don't use each year. Finally, having an FSA may also restrict your ability to use and fund an HSA.
What to Do
If you don't have access to an HSA, an FSA is a good alternative. Since the FSA money is use it or lose it, you will want to contribute exactly the amount you expect to spend. Calculate your annual qualified medical costs and contribute that amount to your FSA. If you are unsure of the exact amount, it is better to contribute less and lose a little tax benefit than to contribute more and lose some of your pay.