Friday, October 22, 2010

Q&A Series – Health Savings Accounts and Flexible-Spending Accounts

This week’s questions come from Ken, a client who is interested in learning more about Health Savings Accounts (HSAs) and Flexible-Spending Accounts (FSAs).

Q: Please explain Health Savings and Flex-Spending Accounts.

Open enrollment time and health-care reform have caused many folks to take a look at HSAs and FSAs and see if they might be a good option for their particular situations.

So, what are these accounts, and what are their advantages and disadvantages? A Health Savings Account (HSA) is just that – a savings account established by individuals and employers wherein the money contributed is used for medical purposes. HSAs are advantageous because the funds are not subject to federal taxes when deposited and the contributions are tax deductible (up to the maximum contribution amount set each year and only if you are not enrolled in Medicare Part A or Part B). Furthermore, the contributed funds grow tax-free and the withdrawals utilized for qualifying medical expenses are also tax-free.

HSAs are especially attractive because the funds roll over from year to year, meaning that whatever funds you don’t withdraw from the account can build over time. You are also not mandated to seek reimbursement for your medical costs from your HSA each year. Therefore, instead of turning in your minor expenses for reimbursement from your HSA, you can continue growing the account so that you will be in a better position to pay for any expensive medical costs that arise down the road. Additionally, like an IRA, you can invest your HSA money in stocks, mutual funds and bonds, which provides for further tax-free growth potential for use specifically on health expenses.

The theory is that when you pay your own medical costs, it makes you use medical services less (which is a good thing). Proponents believe that HSAs are important to reducing the overall cost of health care and making the health care system run more efficiently.

It’s important to keep in mind that you can only qualify for an HSA if you have a health insurance plan – specifically, a High Deductible Health Plan (HDHP). HDHPs have low monthly premiums, but cost more in out-of-pocket expenses. However, these expenses can be paid for with your HSA. The deductible must be at least $1,200 for single coverage or $2,400 for family coverage to qualify.

Flexible Spending Accounts (FSAs) are offered by employers to assist employees in saving a percentage of their earnings on a pre-tax basis to pay for medical and dependent care expenses, reducing the amount of the employee’s income that is subject to tax. The dependent care portion of FSAs is invaluable, as it helps subsidize child care costs for working families up to a maximum of $5,000 per year, tax-free.

FSAs are different from HSAs in that you don’t need to be covered by an insurance plan in order to have an FSA. You also must spend all of the money you have contributed within the coverage year, as whatever remains at year-end is forfeited. In other words, you must “use it or lose it.”

Basically, the employee calculates his or her medical and dependent care out-of-pocket expenses for the year to determine how much they want withheld from each paycheck (the figure should be fairly conservative to avoid any potential forfeitures at year-end). The employer holds these savings in a special account and, as the employee incurs medical and dependent care expenses, he or she submits to the employer the provider’s invoice along with proof of payment. The employer then issues a reimbursement check to the employee out of the special account. Easy peasy, right?

Q: Can you have both?

In general, no. But in particular situations – like if your FSA is limited to preventive care, vision or dental (“limited purpose”), or only pays for medical expenses after the HDHP deductible is met (“post-deductible”) – then you may still be eligible for an HSA. Furthermore, if your spouse has an FSA or HSA through his or her employer that pays any of your expenses before your HDHP deductible is met, then you cannot have an HSA.

Q: What will the new limits be?

The health-care reform bill actually made very little changes to HSAs, the biggest being the increase in penalty from 10% to 20% for withdrawing the money for nonmedical expenses before age 65 which will take effect in 2011. Also, beginning in 2011, over the counter drugs that are not prescribed by a doctor – except for insulin – are not reimbursable expenses under HSAs or FSAs.

By far, the biggest change concerns the maximum allowable contribution to FSAs. In years past, there was no maximum contribution amount for the medical portion of FSAs (although most firms capped contributions at $5,000 per year). Beginning in 2013, however, annual FSA contributions for medical expenses will be limited to $2,500 per year, making them less appealing. Contributions for dependent care expenses under FSAs will remain capped at $5,000.

On the other hand, HSA contributions will continue to be determined by the cost of living. For 2011, individuals with employee-only coverage can contribute up to $3,050 while those with family coverage can contribute up to $6,050. If you’re 55 or older, you can also make a $1,000 catch-up contribution. Furthermore, the maximum reimbursement amount for 2011 under HSAs, including deductibles, will be $5,950 for single coverage and $11,900 for family coverage.

Ken, I hope my answers above have given you and our other readers some insight regarding HSAs and FSAs. There are pros and cons to each type of account, and therefore, it’s important to assess your health and financial circumstances to determine if one or the other – or both, in limited circumstances – is appropriate for you.

We encourage our clients and readers to send us questions for our Q&A series at And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Joe Rollins