Put company benefits and IRS regulations together, and you’re just asking for complexity masked as an acronym. Many employers provide access to Flexible Spending Accounts (FSA) or Health Savings Accounts (HSA) to employees to allow pre-tax payments of various expenses. Let’s dive into the different types and strategies around each.
Flexible Spending Accounts (FSA)
There are actually three types of Flexible Spending Accounts (FSA). We’ll go through each type and a general strategy around using them.
- Health Care FSA (HCFSA)
- Dependent Care FSA (DCFSA)
- Limited Health Care FSA
Health Care FSA (HCFSA)
Health care FSA (HCFSA) is an account that allows for any eligible medical costs to be paid with pre-tax dollars. A HCFSA has the most flexibility of the three FSA types, but cannot be used with an HSA (see below). This is the main vehicle for non-HDHP (High deductible health plans) to budget and pay for expenses pre-tax.
There are some things to consider with a HCFSA. First, the annual contribution limit for 2023 is $3,050. Additionally, the majority of HCFSA money must be used in the year it is contributed, or it is forfeited. This is why in December there are always ads for “Using up your FSA money before it expires”. Some HCFSA plans allow for a carryover to future years, up to $610, while others may offer a grace period that you can submit expenses incurred in the previous year.
The first step in utilizing a HCFSA is to understand how much (if any) can be rolled over to future years. Then, calculate the approx. amount that you are certain you will use in the upcoming year. For instance, if you can roll over the maximum $610 to the following year, and you have another $800 in expected expenses, I would plan on saving $1,410 to a HCFSA. This will allow you to get the full pre-tax benefit but will also not put any money at risk for forfeiture. If your expenses end up being higher than $800, you will have another $610 that will be available to cover those costs before you must come out of pocket.
Dependent Care FSA (DCFSA)
Dependent Care FSA (DCFSA) is known by many different names, such as childcare FSA, dependent FSA, etc., but all refer to the ability to set aside pre-tax money towards dependent care spending. This includes daycare, preschool, before and after-school programs, summer day camp and even certain Eldercare expenses.
For 2023, the DCFSA contribution limit is $5,000 per household or $2,500 for married filing separately. Note that childcare expenses are eligible up until the child reaches age 13. DCFSA can be offered, regardless of the healthcare plan that is provided.
Since average infant care costs in every state exceed the DCFSA limit of $5,000, those that have childcare costs should have no problem using the full amount. Otherwise, it makes sense to plan out your eligible Dependent Care expenses and contribute this number to your DCFSA. Note, there is currently no rollover provision, meaning every dollar in a DCFSA is “use it or lose it”.
Limited Health Care FSA
A Limited (Purpose) Health Care FSA is an FSA used in conjunction with a Health Savings Account (HSA). The purpose of the Limited Health Care FSA is to allow for additional pre-tax payments for eligible dental and vision expenses. In 2023, the contribution limit is $3,050. We’ll talk about the strategy with the HSA below.
Health Savings Accounts (HSA)
Health Savings Accounts are a savings account tied to High Deductible Health Plans (HDHP). This allows pre-tax payments for many eligible medical expenses. HSA funds carryover indefinitely, so you do not need to worry about limiting your contributions.
For 2023, the family contribution limit is $7,750 and $3,850 for self-only. This contribution can happen any time throughout the year and can even be made the following year if completed before the April 15th tax filing date.
Many employees believe that they must use their employers’ recommended HSA, but as long as your health insurance plan is HSA-eligible, you can open your own HSA at any provider. This can be useful if you are looking to invest your HSA funds for long-term growth.
For high income earners looking for additional savings options, HSAs are an incredible savings tool. It has been described as a “Triple-tax Savings” vehicle. This is because the money goes in pre-tax, then can be invested, with the gains not taxed, then, if used for eligible health expenses, will be withdrawn tax-free.
If you can afford it, you should plan on maxing out your HSA contribution each year. (Note: once you enroll in Medicare Part A at age 65, you can no longer contribute to the HSA).
If you can keep your funds in your HSA by paying expenses out of pocket, you can invest for future medical expenses. Many HSA plans allow for investment in a wide range of stocks, bonds and mutual funds.
One little “loophole” in the HSA regulations is that you can reimburse yourself at any time for expenses paid once the HSA was opened. One strategy, which takes a little extra accounting, is to keep a copy of all receipts for eligible expenses. Then, even years later, after the account has been invested, you can pull out reimbursements for old expenses tax-free. Many choose to plan for health expenses in retirement, including using HSA funds to pay for Long-term Care Insurance Premiums.
If you decide to invest for the long-run and run out of expenses to cover a tax-free withdrawal, you still will have options. Worst case scenario, you can use the money from HSA for any expenses after age 65. There is no penalty for funds used after age 65, but you will owe taxes on non-medical expenses, making this HSA similar to an IRA.
Between three FSAs and an HSA, there are many options and rules to follow when paying for eligible expenses. However, with a little planning and strategy, you can use these vehicles cleverly to your benefit. If you have a question about your current FSA vs HSA and want to know if there is a better way to use this money, please reach out!