In November, many Americans will be choosing their healthcare benefits for 2024, either through their employers or the U.S. healthcare exchange. Along with medical insurance options, you may have an opportunity to invest in a health flexible spending arrangement (FSA) or a health savings account (HSA). Choosing the best one for your needs, however, depends on how you plan to use the money.

Both FSAs and HSAs allow you to put aside money for healthcare expenses in a tax-advantaged way. But they also have a few major differences, including who qualifies, how much you can contribute each year, and how long you can wait to spend the money on qualifying medical expenses.

Flexible Spending Arrangement (FSA)

Also known as a flexible spending account, a flexible spending arrangement typically enables you to make contributions via pretax salary reductions. You can then use the money to reimburse yourself for qualifying medical expenses, such as co-insurance payments, deductibles, prescription drugs, over-the-counter medications, glasses, and hearing aids, among others. For 2024, the maximum plan contribution limit is $3,200, up from $3,050 in 2023. If you are married, your spouse can contribute up to the same limit in an FSA with their employer too.

Key Points:

  • Generally, FSAs are a “use-it-or-lose-it” account, meaning you must use all of the funds in your FSA account in a year. In 2023, some employers offered employees a grace period of 2 1/2 months to use any leftover money, or the IRS allowed employers to carry over up to $610. Employers didn’t have to offer either of these options, and they could not offer both.
  • You can only use FSA money on “approved” medical and dental expenses, according to the IRS.
  • FSAs stay with your employer. They cannot move with you to another job.
  • You can’t use an FSA with a Marketplace plan.

Health Savings Account (HSA)

A health savings account must be combined with a qualified high-deductible health insurance plan. Like an FSA, HSAs can be used to pay for certain medical expenses, but they can also be used as a long-term savings vehicle. Unlike FSAs, which ordinarily must be used within the plan year, HSAs don’t have a “use- it-or-lose-it” component. For 2024, individuals can contribute up to $4,150 for themselves or $8,300 for family coverage. Taxpayers aged 55 and older can make an additional $1,000 catch-up contribution. For those who can cover their high deductible costs without dipping into their HSA contribution, HSAs offer some major advantages.

Key Points:

  • HSAs offer a triple tax benefit. First, contributions are tax deductible. Second, funds inside the HSA grow tax-free. Third, withdrawals are also tax-free when used to pay for qualified medical expenses.
  • HSAs stay with the account holder, so if you move to another job, you won’t lose the money you contributed.
  • You have the option to roll your contributions and your employer’s contribution out of an employer’s plan once a year to a separate plan, if you prefer to manage it yourself or have an advisor manage it. (Your outside plan may or may not offer less expensive investment options.)
  • You can also make a one-time rollover from your IRA to fund your HSA. This can be a tax-savvy move for individuals with large IRA balances who are approaching the age where they will have to take required minimum distributions.
  • You cannot contribute to an HSA once you go on Medicare, but you can continue to use the funds you have already contributed.
  • You can withdraw funds from your HSA for non-medical expenses, but you can expect to pay ordinary income tax as well as a 20% penalty. If you are 65 or older, you won’t be penalized, but will still be taxed for non-medical expenses.
  • You can invest your money in an HSA they same way you invest in an IRA. This enables your HSA to grow faster than if you simply put the money in a savings account.

Which Account Is Best for You?

Before deciding whether to contribute to an FSA or HSA, talk to your advisor about the advantages and disadvantages of each as they relate to your situation, as well as comparing the various deductibles and benefits of your health insurance options. If you tend to visit the doctor often, have high medical bills each year, or don’t want to enroll in a high-deductible healthcare plan, an FSA may be the right choice for you. On the other hand, if you are fairly healthy and have the ability to absorb a high deductible through other means, an HSA might be the better choice. In some cases, you may be able to participate in both an HSA and a limited FSA, which only allows use for qualified dental or vision expenses. Check with your employer for all of the details of your plan.

An HSA can be a powerful tool in a retirement portfolio, and an excellent way to pay for healthcare costs in retirement. With studies predicting that the average 65-year-old couple will need approximately $315,000 (after taxes) to pay for healthcare costs in retirement (not including long-term care), those who can afford to invest now for their future healthcare needs may feel an extra sense of relief later in life.

This is intended for educational purposes only and should not be construed as personalized investment or tax advice. Please consult your financial professional regarding your unique situation.

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