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Open Enrollment 2018 - HSA, FSA, HDHP - What Do They Mean?

Health Taxes Planning

As fall approaches, it is once again time for many of us to review benefit options during an employer sponsored open enrollment period.  One source of confusion during enrollment centers around health care reimbursement accounts.  It can be ever more confusing when acronyms such as, FSA, HSA and HDHP are used as if they mean something intelligible. The good news is that these acronyms can be understood and each offers some potential benefits.  I will do my best to demystify these acronyms and provide you a solid understanding for reviewing your benefit options.  Please note that this blog has been updated from last year's post using 2018 numbers where available.

Flexible Spending Account (FSA)

Flexible Spending Accounts (FSA) are tax-advantaged savings accounts offered by your employer. You can contribute pre-tax dollars to the account.  The funds can be used to pay for qualified medical, dental and vision related expenses as they occur.  This type of benefit is typically offered with health insurance plans not considered High Deductible Health Plans (HDHP) which will be discussed later.

Benefits

  • You can defer up to $2,600 of income for 2017 (the 2018 number has not been released).  These funds are not subject to Federal Income or Social Security (FICA) taxes.
  • Health related reimbursements are tax free if used for copayments, coinsurance, deductibles, prescription medications, and dental and vision care per the IRS.
  • Employers can make contributions on your behalf.
  • You have access to the entire amount you elected to contribute for a year at any time.  This means that if you elected to contribute $2,400 for the year, or $200 a month starting in January, you could use the entire $2,400 in January.  If you happen to leave your employer before making all of your contributions, say in March, excess funds do not have to be returned.

Potential Drawbacks

  • You cannot use the funds to pay for insurance premiums.
  • You can only change your election amount during the year if you experience a qualifying event such as a marriage or birth of a child.   The specifics behind this option can be plan dependent.
  • Your FSA account is owned by your employer, so if you leave your job you cannot take the account or any funds you deposited with you.   If you are leaving, make sure to schedule any doctor appointments you may have put off right away!
  • FSA’s are “use it-or-lose it,” meaning the funds in your account will expire at the end of the year. However, employers do have two options to prevent employees from losing any funds remaining at year’s end. The first allows you carry over up to $500 to the next year. The second offers a grace period for two and one half months to spend any leftover funds. Your employer can offer either option, but not both.
  • Your employer may require you to submit receipts for all funds spent from the account.  This is referred to as substantiation.  Many of you know how irritating it can be to scan, copy, fax and/or mail all of this paperwork to the plan administrator. 

Health Savings Account (HSA) and High Deductible Health Plan (HDHP)

Health Savings Accounts (HSA) are tax advantaged savings accounts designed to complement a High Deductible Health Plan (HDHP). An HDHP requires you to retain a substantial portion of the cost for your healthcare and pay sizable upfront deductibles for most health expense before your coverage kicks in.

It is beyond the scope of this blog to go into all the requirements for a plan to be consider a HDHP.  However, it must meet certain limits like a minimum deductible of $2700 for 2018 with a maximum out of pocket amount of $13,300 for a family.  There are also certain rules regarding items such as prescription coverage, emergency room and office visits.  Please check with your health care provider or benefits administrator to confirm if you plan qualifies as HDHP.

Benefits

  • You can defer up to $3,450 of income for an individual or $6,900 of income for a family for 2018.  These funds are not subject to Federal Income or Social Security (FICA) taxes.
  • If you are 55 or older, you can make an additional catch up contribution of $1,000 for 2018.
  • Reimbursements are tax free if used for co-payments, coinsurance, deductibles, prescription medications, and dental and vision care, per the IRS. 
  • Employers can make contributions on your behalf.
  • You own the account.  This allows you to take the account with you should you leave your employer. 
  • If you have the cash flow to cover your medical expenses, you typically have the option to invest some of your account in mutual funds.  Any related dividends, interest and capital gains are not taxed like an IRA.
  • Unused HSA deposits and associated income carries forward from one year to the next to use tax free for qualified medical expenses.  Once you reach age 65, you can use the funds for anything.  However, the withdrawn funds will be subject to ordinary income taxes.
  • You can change your election amount so long as you do not exceed the IRS limits for a year.
  • Under certain circumstances, you can pay for insurance premiums. Generally, this applies to:
  1. Long-term care insurance, subject to IRS mandated limits based on age.
  2. Healthcare continuation coverage such as coverage under COBRA.
  3. Healthcare coverage while receiving unemployment compensation under federal or state law.
  4. Medicare and other healthcare coverage if you are 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap).

Potential Drawbacks

  • You only have access to funds that are in the account.  If you experience a large claim and you don’t have enough in the HSA to cover it, you will have to pay for the expense and then submit a reimbursement claim once you have enough funds.
  • The HDHP plan, in conjunction with your health insurance premiums may not be an affordable option.
  • Your employer is not required to request receipts for expenditures.  However, you will be required to account for HSA contributions and withdrawals when you prepare your income taxes. You also need to be prepared to provide receipts should you undergo an IRS audit.
  • You are not eligible to make HSA contributions if you are enrolled in Medicare.
  • Funds withdrawn prior to age 65 and not used for qualified expenses are typically subject to ordinary income tax and a 20% penalty tax.

Limited Flexible Spending Account (Limited FSA)

Could your health care spending account options get any more complicated?  Sure, you may be able to contribute to a Limited FSA in conjunction with your HDHP and HSA.  Overall, the benefits and potential drawbacks are similar to an FSA.  However, there are a few key distinctions to keep in mind.

  • You can only use the funds for qualified dental and vision expenses until your HDHP deductible is met for the year.  Typically you have to notify your FSA administer by signing off on a form.  Once the HDHP deducible is met, you can use the Limited FSA funds for other qualified medical expenses.
  • People typically fund both an HSA and a Limited purpose FSA if they have the cash flow to meet their medical expenses, fully fund an HSA, and are trying to defer using their HSA. This allows individuals to use their FSA for medical expenses once the HDP deductible is met.  However, you need to plan accordingly so that you have time to use any limited FSA funds before they expire. 

Summary

For each health care spending account option, you need to review your overall situation including cash flow needs, tax situation and retirement before deciding if, and how, to best use these accounts. There are many potential benefits, but you need to be aware of the potential drawbacks.  Please consult your human resource team, benefits administrator, and/or financial professional to make sure you use these tools wisely.

 

*This blog is not to be construed as financial planning or tax advice, but for educational purposes only.