Whether you have health insurance or not, if you spend money on healthcare, taking action to set up a tax-advantaged account could save you money.
Two common accounts that could help your personal budget's bottom line are the flexible spending account and the health savings account. Which choice is best for you? The answer depends on a lot of things.
Here’s how they stack up:
Tax-Advantaged Accounts: What They Are
Flexible spending accounts (FSAs) are provided by employers and allow you to take pre-tax money out from each paycheck. The money is then earmarked to go toward certain health related expenses. Typically you’ll either receive a debit card that you can use to pay for qualified health expenses, or after you pay for your medical expenses, you’ll fill out a claim form and be reimbursed with the funds in your account.
Health savings accounts (HSAs) allow you to invest the pre-tax money you’re setting aside for health care costs in mutual funds and other investment vehicles and, ideally, watch your contributions grow. Neither of these accounts requires you to pay taxes on the amounts you take out, as long as they’re used to cover qualified health care costs.
FSAs are only available if you’re employed and your employer offers them. HSAs are only available for the uninsured and for those covered under a high-deductible health plan—that is, an insurance plan in which you have to pay a relatively large sum on your healthcare before your benefits kick in.
This year, the minimum annual deductible to qualify for an HSA is $1,150 for a single person or $2,300 for a family.
What the Accounts Cover
You can use an FSA to cover copayments for doctor's office visits, prescriptions, some medical supplies and even alternative medicine. However, you can’t use FSA money to pay for health insurance premiums or long-term care coverage and expenses.
With a HSA, you can pay for all of the above, including your health care premiums.
Pay Attention to Maxes and Taxes
Although your employer may limit the amount you can contribute to your FSA, which translates to a limit on the amount of tax savings you’ll get, there are still more tax benefits to having this type of account. No employment or federal income taxes are deducted from your FSA contributions, and withdrawals are tax-free if they’re qualified medical expenses.
One of the biggest benefits to an FSA is that you can withdraw funds from the account to pay qualified medical expenses, even if you have not yet contributed those funds to the account in the first place. And if your employer contributes to your FSA, that amount can be excluded from your gross income as long as it doesn’t contribute to your long-term care insurance, according to the IRS.
FSA funds are taken out pre-tax, saving you money by reducing the percentage of your income that’s subject to income taxes. But HSAs are even better because the potential earnings you receive from investment are tax free as well.
For 2009, if you’re single and youre covered by a high-deductible health plan, you can contribute up to $3,000. If you have family coverage under a high-deductible health plan, you can contribute up to $5,950. Whether this way is better or worse than the max on an FSA depends on the limits your employer places on employees’ accounts. For more on tax-favored health plans, consult IRS Publication 969.
Savings Do Not Roll Over: Use It or Lose It
One major downside to FSAs as opposed to HSAs is that remaining balances left in FSAs at the end of the year are forfeited according to a use-it-or-lose-it policy. So you’ll have to calculate how much you spent last year on out-of-pocket healthcare costs and make an estimate for this year.
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