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FSA or HSA: How to best maximize your health savings

  • Flexible spending and health savings accounts enable you to put away pretax funds for medical expenses.
  • Savers need to know the particular rules of, and differences between, these accounts to make the best use of their savings.
Many advisors are now touting HSAs as one of the best ways to save for retirement.
Savushkin | Getty Images
Many advisors are now touting HSAs as one of the best ways to save for retirement.

You've likely heard that you can reap great tax benefits by putting money in health savings and flexible spending accounts to cover health-related expenses.

But what is the difference between the two accounts?

Both types of accounts can "make your paycheck go farther," said Jody Dietel, chief compliance officer at WageWorks, a provider of health, commuter and employee-benefit plans.

Flexible spending accounts are more widely used by savers, with WageWorks estimating there are three participants for every one health savings account holder, Dietel said. They are also not a perk for the rich, according to Dietel. Savers using both kinds of accounts have an average household income of $57,000 a year, she said.

Here's what you need to know to make one or both accounts part of your savings plan.

Flexible spending accounts

A flexible spending account is offered at your employer's discretion and allows you to sock away pretax funds for qualified medical expenses. The maximum amount savers can put in these accounts in 2018 will be $2,650, a $50 increase from 2017, according to the IRS.

The funds can be used for medical expenses that are not covered by a health plan, including co-pays, deductibles, dental and vision care or dependent day care. Eligible expenses can vary with specific plans.

Money in flexible spending accounts is generally subject to a use-it-or-lose-it provision. You must use the funds for qualified expenses by the end of year or risk losing the money. Some employers may offer workers a bit more flexibility by either allowing them more time, a grace period or the ability to carry over up to $500 into the next year.

Health savings accounts

Health savings accounts are available to individuals and families who are enrolled in high-deductible health plans.

True to their name, a high-deductible health plan comes with a higher annual deductible than most plans. The plans set a maximum limit on how much you need to pay for your deductible and out-of-pocket medical expenses.

Individuals who hold these accounts will be able to contribute up to $3,450 in 2018, up $50 from 2017. Families will be able to sock away up to $6,900, up from $6,750 in 2017.

Health savings accounts are often touted as triple-tax free. The money you contribute and take out is not taxed, provided it is for qualified medical expenses. Plus, any gains on the money you invest in the accounts is generally not taxed.

But not everyone has access to these accounts. You cannot have other conflicting health coverage or be enrolled in Medicare in order to contribute to a health savings account. You also can't be claimed as a dependent on someone else's tax return.

Health savings accounts are "portable" compared with flexible spending accounts, according to the IRS, because you keep them even if you change employers or stop working. Money in the accounts can also be carried over from year to year.

Also, unlike a flexible spending account, participants can open a health savings account, change their contributions or invest a lump sum at any point during the year, according to financial advisor Wayne B. Titus III, a founding member of AMDG Financial in Plymouth, Michigan.

Owning both accounts

Savers should keep the key differences between the accounts in mind.

For flexible spending accounts, you should look at your medical expenses from the previous year to guide how much you should save, Dietel said. Pay attention to whether your expenses — such as medications, eye prescriptions or dental work — were one-time events or will recur in the coming year.

For health savings accounts, savers should think more long-term.

"Folks should contribute as much as they can to a health savings account because there's no downside to it," Dietel said. "It's probably the best retirement plan going."

Once you turn 65, you can take money out of a health savings account for reasons outside of medical expenses, though those distributions will be subject to income taxes, Dietel said.

Savers who own both types of accounts need to be aware that their flexible spending accounts will likely have restrictions, according to Dietel. For example, savers might be limited to just using their flexible spending accounts for dental and vision expenses.

Retirement strategies

Savers need to be strategic when using health savings accounts for retirement, according to Titus.

Individuals who retire before age 65 when they are eligible for Medicare will have health care premiums to pay. That can be done through their health savings accounts, in addition to covering other health care expenses, Titus said.

"You're doing that with pretax dollars, so it's like you're getting a discount on all the services and premiums that you pay," Titus said.

Savers who plan to hold onto health care savings accounts for retirement should also be aware that they have the ability to roll their balance into another health savings account once a year, Titus said.

You need to make sure the transfer is a qualified rollover, Titus said. But it can pay to shop around to find an account with more attractive fees and investments for your money, he said.

"Very few people actually know about that and do that, and it's probably one of the most powerful options that somebody can utilize," Titus said.