What are Tax Advantaged Savings Accounts?
FSA, HSA, and HRA. These acronyms add to the complexity of open enrollment season. You might be scratching your head and wondering what’s the difference. Are they similar? Which one should I use?
When I think about these things, it makes me think about choosing the right vehicle and reminds me of a funny story. In college, I played on the offensive line. If you’ve never met me in person, I’m a fairly big guy at 6’8” and around 300 pounds at the current time. At the height of my college football career, I was about 330 pounds. Every once in a while, we would use scooters to get around campus. I would drive a little 50 cc scooter which was probably questionable if it could hold me. Sometimes a few of us, up to three offensive linemen, would get on this little scooter and cruise down the road to get to practice or wherever we were going. That’s almost 1000 pounds on this poor little scooter. Not the best choice of vehicle for what we were trying to do. We were young college kids who didn’t know as much as we thought. Eventually, we wore out that scooter and blew the engine. No surprise why. What does that have to do with HSAs, FSAs, HRAs, etc.?
It’s about choosing the right vehicle when it comes to financial instruments. Working out of that are different savings accounts employers often offer employees for their benefit. There are usually some tax advantages to these various savings vehicles, so let’s go through the differences.
FSA (Flexible Spending Account)
There are two variations of flexible spending accounts: healthcare spending accounts and childcare spending accounts. All the contributions that go into the flexible spending account, whether for childcare or healthcare, will be pre-tax contributions. Every dollar you put into a flexible spending account will reduce your taxable income by that much. We all like saving tax money, right?
Here’s an easy example. Let’s say you make $100,000. You contribute $1,000 into a flexible spending account. The amount of your taxes will be based on $99,000. You’re not taxed on the full $100,000. So you get the tax benefit of the money going in.
In addition, any earnings in that account, like interest, are tax-free. These accounts don’t always have interest, and it hasn’t been much in recent years. Still, it’s tax-free if you do earn interest on the money you contribute. You can then use that money throughout the year to pay for your healthcare or childcare costs.
Childcare costs are for children under 12 or 13 and cover things like daycare or after-school care. The account funds cannot be used to pay for K-12 private school tuition.
Healthcare accounts can be used to pay necessary regular medical expenses like routine doctor or dentist visits, lab work, etc. Cosmetic procedures are typically not covered by a flexible spending account. Visit the IRS website to view the list of what is considered a “qualified medical expense.
The primary downside of a flexible spending account is that you lose it if you don’t use the money by the end of the year. If you put in several $1,000 and don’t end up spending it, you don’t get the money back. You should plan appropriately when determining how much to contribute and be sure to use it throughout the year.
From a strategy standpoint, if you’re using a healthcare flexible spending account, you may want to consider putting the amount that is equal to your deductible or out-of-pocket maximum. If you are unsure what these terms mean, I discussed them in a previous article which you can find here.
Using a flexible spending account is especially valid if you don’t have the means or the inclination to build a healthy savings account. If you already have a healthy savings account, you may not want to use a flexible spending account because of the potential for losing money at the end of the year.
HSA (Health Savings Account)
Many people think HSAs and FSAs are the same, but they’re not. The health savings account can only be used for a high-deductible insurance plan. FSAs can generally be used with any sort of health insurance plan.
The health savings account is also considered to be pre-tax dollars. Returning to the example, you make $100,000 a year and contribute $1,000. You will only be taxed at $99,000 of income.
The key difference with the health savings account is that whatever you put in there will continue to accrue and can be rolled over yearly. This means you don’t have to use all the money in the same year you contribute, which is a huge benefit for this type of account. If you put in $1,000 and you don’t use it, the $1,000 would still be there in future years to use if you need it down the road.
What’s also nice about the health savings account is that you can often invest the money. It’s important to note that the provider will usually limit how much you are required to keep in the account in cash. Once you have above that amount, you can invest the money. All of the potential earnings, if you have gains, are going to be tax deferred.
If you end up using the money for a qualified health expense, it’s considered a tax-free expense. The significant difference between a flexible spending account and a health savings account is that you can contribute to it. In some cases, your employer contributes to it as well. If you don’t use the money in your health savings account, it continues to grow tax-deferred and potentially tax-free if used for qualified medical expenses. That is a wonderful benefit of a health savings account.
HRA (Health Reimbursement Account)
A health reimbursement account is somewhat of a combination of the flexible spending account and the HSA. This type of account is usually only funded by the employer. You don’t contribute any money to the HRA yourself. Your employer will contribute a specified amount, and the funds can be rolled over yearly like an HSA. The money can accrue without you having to use it if you don’t have any health expenses that come up that year.
HRAs are often tied to specific health plans that your employer may offer, so you’ll definitely want to check with your employer on which one you have access to.
Which one should I use?
It’s a little complicated, but I might ask a few questions when deciding which one to use.
What are your options?
Which of the following are options based on your situation and employer?
- Is your only option an HRA set up and contributed to by your employer
- Do you have different types of health insurance plans that offer HSA or FSA
- Is there a high-deductible plan option
People who are relatively healthy and don’t visit the doctor often and those with health problems that require lots of doctor visits that typically max out their deductible may want to look at a high deductible insurance plan with a health savings account.
If your health is somewhere in the middle, you may lean more toward the FSA with a more comprehensive health insurance plan. This option may offer better overall savings for you. You have to run the numbers between your expected health costs and how much you can put away into the flexible spending account.
What is your overall situation?
Some other things that need to be considered when deciding which tax savings account may be best for you include:
- Your age
- Current financial situation
- Past medical spending
I hope this has helped clarify some of the differences between flexible spending, health savings, and health reimbursement accounts. If you have questions, I would be happy to meet with you to discuss your situation.
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