Health Care costs and tax rates are only expected to go higher as we face up to an aging population as well as a national debt level that is simply staggering. Given this, it makes sense for each of us to look for relief wherever we can find it. Two financial tools that can often make a positive difference are flexible spending accounts and health savings accounts, but which one is best for you? Let’s take a look.
FSA – Flexible Spending Account
The flexible spending account is tied into what is known as a cafeteria plan supplied by an employer. The account is authorized in section 125 of the internal revenue code, and is basically designed to give employees the ability to pay for certain expenses with pre-tax money. The employee selects an amount of money he or she wants deducted from each paycheck with the money being contributed to the account. Once in the account, the money is used to pay defined allowed expenses. These are often medically related, but can also be used for things such as care of dependents. Importantly, the money must all be used during the one year term of the account. If a balance remains at the end of the year, it is forfeited by the employee.
HSA – Health Savings Account
The health savings account was created in the tax code in 2003. It is a unique financial tool was created with the intention of trying to help people struggling with expensive health insurance premiums.
I don’t have to tell you that the cost of health insurance is very high. Many people are having problems paying for it. To address this, insurance companies are now offering what are known as high deductible health insurance plans that have much lower premiums. To keep prices low, one of these policies might have a deductible of $3,000 or so. This simply means the insured person must pay the first $3,000 in medical bills before the policy kicks in. Since most people don’t incur medical bills over this amount in a year, the insurance company charges much lower premiums. People who would otherwise be unable to afford any health insurance are then able to take advantage of these plans and have coverage if something serious like a sudden need for surgery arises.
The health savings account is designed to make using the high deductible health plan easier. The “HSA” lets a person save up to the deductible amount income tax free each year. The money is then used to pay any medical bills incurred until the deductible is used up. At that point, the health insurance kicks in and covers any further expenses.
The FSA and HSA are often mixed up in financial discussions given their similar names. In truth, they are very different. A major difference between the two plans is the money in an HSA is not forfeited at the end of the year as is the case with the FSA. Instead, it rolls over to the subsequent year where it can be used to cover the high deductible for the health insurance policy.
The FSA does, however, have some advantages over an HSA. The primary one is the FSA can be used to pay a wider variety of expenses. For example, an employee can use their account to pay for daycare for their kids. The HSA, in contrast, can only be used for medical expenses.
So, which plan wins in the comparison of these two accounts? The answer depends on the expenses you want to cover. If medical expenses are your only concern, an HSA may be the best answer. If other expenses are a concern, then you may want to migrate to the FSA if your employer offers it.