June 29, 2011

pill-piggy-bankHSAs and FSAs let you save by using pretax money for health care costs.(ISTOCKPHOTO)Chances are, youve heard of flexible spending arrangements (FSAs) and health savings accounts (HSAs). But what are they exactly? Whats the difference between them? And most important, can they save you money? The answer to the last question is: absolutely. Heres what you need to know about health savings accounts and flexible spending arrangements to help pay your health-care bills.

Flexible spending arrangement
What it is: A flexible spending arrangement (FSA), often called a flexible spending account, is a benefit that may be offered by large employers. It allows you to put aside money from your paycheck before it is taxed to pay health-related expenses that aren't covered by your insurance. By using pretax dollars, "you're effectively buying health-care services at a significant discount," explains Wayne Farlow, a certified financial planner, whose firm Financial Abundance LLC, is based in Westminster, Colo. How big a discount, of course, depends on your tax bracket. The higher that is, the more your savings. For the average wage earner, it translates into at least a 30% savings on your health-care expenses.

The money taken out of your paycheck is put aside in an account that your employer (or a subcontractor hired by your employer) oversees. You might be issued a debit card to pay for expenses directly, or your company might require you to submit receipts for each reimbursement. The legal limit of the account is $5,000, though some companies may have lower maximums.

Next Page: The catch [ pagebreak ]There is one catch: You must use the entire amount of the FSA by the end of the benefit period or the funds go back to the plan, which your employer typically uses for other benefits. This "use-it-or-lose-it" feature often scares people away from signing up for FSAs, says Jerry Ripperger, director of consumer health for the Principal Financial Group in Des Moines, Iowa. To determine how much you should set aside in your FSA, go through a typical year's records—not one in which you incurred a lot of unexpected expenses—and tally your health-related costs not covered by insurance. If youre close to losing money, try to move up an elective procedure that you may have been planning for the following year.

What it can be used for: Money in your FSA account can be used for a broad range of medical expenses, such as acupuncture, braces, eyeglasses, hearing aids, insurance co-pays, medication, and deductibles.

How you save: "The FSA may be the most underutilized tax-advantaged vehicle the government has given us," says Ripperger. Since the money you put in the account is not taxed, there is more of it—100%, rather than the 70% or so after taxes—to spend on health-care needs. And because the money is subtracted from your pay before taxes, your overall taxable income is lowered, reducing the amount of taxes you owe at the end of the year. The savings are significant: Someone in the 25% tax bracket, for instance, will get a discount of about 37% on health-care costs that are paid with the money in their FSA.

Bottom line: If your company offers an FSA, sign up. "[But] dont get overly aggressive on your calculations," Farlow advises. Try to be realistic and conservative about how much money you will spend each year so you dont end up losing any money left in the account.

Next Page: Health savings account [ pagebreak ]Health savings account
What it is: A health savings account (HSA) also allows you to save untaxed income to pay for health-care costs, both in the short- and long-term. To be eligible, you must be enrolled in a high deductible health plan (HDHP), which the IRS defines as a plan with an annual deductible of at least $1,100 for individuals or $2,200 for families. To help offset the high deductible, you (or your employer) can deposit money into an HSA maintained by a financial institution, up to a maximum of $2,900 for an individual account and $5,800 for a family account. (Individuals 55 and older can deposit an additional $900.) You can use those funds to pay for medical expenses until you reach your annual deductible, and, after that, to pay for expenses that arent covered by your health plan. To use your HSA funds, you are issued a debit card that subtracts money directly from the account, although in some cases you may be required to submit receipts to the account trustee for reimbursement.

Almost anyone with an HDHP is eligible for an HSA, with some exceptions (such as people on Medicare). Importantly, unlike an FSA, any money thats left over at the end of the year in your account can be carried over and used for future medical expenses. You can have both an HSA and certain types of FSAs, if your company offers both.

What it can be used for: In addition to routine medical expenses like doctors visits, prescriptions, and lab work, you may also use the money in your account to pay for medical expenses not covered by your insurance. You can also pay for long-term-care insurance premiums, and health-insurance premiums when unemployed or when receiving continuation coverage (such as COBRA). You cannot use an HSA for a Medicare supplemental policy such as Medigap.

Next Page: How you save [ pagebreak ]How you save: “The funds are triple tax-free,” says Dan Perrin, president of the HSA Coalition in Washington, D.C., and the author of HSA Road Rules. You save three times over since taxes aren't taken out of the money you put in, interest earned by money in your account is tax-deferred, and no taxes are owed when you withdraw the funds to pay for qualifying medical expenses.

HSAs most clearly benefit either very healthy people or people with chronic illness. The high deductible health plans that an HSA must be paired with usually have lower premiums than traditional ones, so if you are young and healthy and dont incur many medical expenses, you can save with the lower premiums. And any money you put into your HSA that is not used can be considered part of your savings. HSAs are often compared with IRAs because the more money you leave untouched in your HSA, the more money will accumulate in your account that you can then use for the greater health-care expenses that will likely come in your retirement years.

You can still save with an HSA even if you have high medical expenses and you need to use the funds. Perrin points out that, with an HDHP, once youve met your deductible, the plan covers 100% of in-network health expenses, whereas some traditional health-insurance plans only pay 80% of your in-network medical costs. The remaining 20%, plus deductibles and co-pays, can add up to more than youd pay with an HSA and high-deductible plan if you have a chronic or catastrophic health problem—for instance, if you have type 2 diabetes or are diagnosed with breast cancer and require chemotherapy and surgery.

Bottom line: If you are young and healthy or do not have access to an employer-paid plan, in all likelihood an HSA is a good idea. It also may be recommended if you have a chronic or serious medical condition and an insurance plan that does not cover 100% of your expenses. If you can afford health insurance now, you can afford to refinance your account, advises Perrin, who adds that he would recommend an HSA for anyone who feels comfortable being in charge of his or her own health care—that is, deciding what to spend your money on without the help of an insurance program.

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