Health Savings Account vs. Flexible Spending Account
When it comes to individual health insurance, there are a number of options, but many don't cover for paying for out-of-pocket medical expenses. This doesn't mean there's no help to be had. The IRS allows for special accounts that assist in paying for such expenses through either a health savings account (HSA) or a flexible spending account (FSA).
The Differences Between an HSA and FSA
A flexible spending account is a special account set up by employers for their employees, as permitted by Section 125 of the Internal Revenue Code. The funds deposited into the account are untaxed and can be used at will by the owner of the account for any medical expense approved by the IRS.
A health savings account is similar in that it's an account set up via an employer and the holder of the account can deposit money into the account. There is a catch with an HSA, however. The account holder can only add funds up to a predetermined limit imposed by the rules set forth by the IRS. This account is also deductible for federal income tax purposes, but they are not exempt from Medicare and Social Security taxes. Again, the funds can be withdrawn for approved medical expenses at any time. Unlike the flexible spending account, HSA funds can be withdrawn for non-approved purposes, but the account holder will be charged a 10% penalty fee. For individuals over the age of 65, that fee is waived.
Eligibility for these plans is not unconditional. The complexities of the flexible spending accounts often scare off small business owners. Participants are only eligible through their employers, as stated by the Internal Revenue Code. Additionally, the savings account can only be opened by those with an individual health insurance. The insurance plan must have a high deductible, so HSA plans are unattractive to most taxpayers.
The flexible spending account may limit how the funds can be used, but there is an allowance for using money from the account to cover home health care costs. This may provide a way of utilizing the funds before they expire. Unlike the savings account, money deposited into the flexible spending account must be used within two and a half months of the year in which they were deposited. After that limitation has expired, the account holder forfeits access to the money.
A Detailed Look
Already, it seems apparent that there are both drawbacks and benefits to both types of accounts. It may be confusing to understand which option is best for your circumstances, so let's take a deeper look at the various aspects of the account options. As is the case with any type of account, there are details that can make your choices less complex.
One such example comes with the payment of interest. If you assumed the flexible spending account would not accrue interest, you would be correct. The same cannot be said for the health savings account, however. Interest accrues in many HSA plans on a tax-free basis. The health savings account also allows participants to make catch-up contributions, starting at age 55 and lasting until they are eligible for Medicare.
What expenses are allowed? That seems to be the biggest mystery. In fact, both the flexible spending account and the HSA can be used to cover any "otherwise unreimbursed medical expense". In both cases, this does not cover health insurance premiums, as a premium is not considered a direct medical expense.
Another option that may make HSA plans preferable is that the account holder owns the account. In a flexible spending account, on the other hand, the employer owns the account and the employee is limited in how he or she can fund the account. For the savings account, other individuals can fund the account on the account holder's behalf. This may come in handy in cases where the account holder becomes ill and cannot make his own deposits. A relative or spouse can make the deposit instead.
As was previously mentioned, funds not used before a preset deadline in a flexible spending account will be lost. In HSAs, however, those funds are not lost to the account holder. Instead, they roll over from year to year, so they can multiply from year to year, making a greater amount available in the event of a serious injury or illness.
While each type of account does have its unique set of drawbacks and limitations, maintaining one or the other can aid in saving up for the unthinkable. As we get older and face the increased chance of a long hospital stay or costly medical procedure, it may be comforting to know these options exist. Speaking with your employer to find out what options they offer may be the first step in securing a better financial buffer for later years.