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.
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 recordsnot one in which you incurred a lot of unexpected expensesand 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.
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.
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.